A major development in industrialized countries over the past decade has been the growing modernization, deregulation and integration of financial markets. This in turn has produced increased competition among the suppliers of financial services. Although this increase in competition has resulted in increased efficiency in the allocation of financial resources, it has also brought concerns about a decline in the franchise value of the banking industry i.e., the value of the business that distinguishes banks from other financial intermediaries.

This paper deals with the recent evolution of the franchise value of banks in the United States and Japan. The problems of banks in the United States are well known. Twice in the last five years, provisions for bad loans have more than wiped out the aggregate net income of American wholesale banks, and they have been forced to pay dividends out of capital. In addition, after an extended period of maintaining a high return on equity, Japanese banks have also recently been experiencing downward pressure on earnings and on capital. This paper argues that the franchise value of wholesale banking in the United States and Japan has declined, increasing the incentives for risk taking by banks. Specifically, the paper maintains that the decline in franchise value has led to increased risk taking on the part of wholesale banks in the United States and to a decline in earnings at Japanese wholesale banks.