Do Banks Benefit When Their Clients Merge? Evidence from Japanese Mergers

Abstract

This paper conjectures that when a bank’s borrowing clients merge, the merger reduces the bank’s risk. Because banks that reduce their risk can better comply with capital adequacy requirements and avoid hefty regulatory costs, this paper hypothesizes that banks benefit from client mergers. Using data from Japan in 1990-2004, when Japan’s banking sector suffered from severe capital loss and was under huge pressure to report capital adequacy, this paper documents two findings consistent with this hypothesis. First, banks of the merger firms on average gained positive abnormal returns upon announcements of mergers between their clients. Second, wealth gain to banks partially stemmed from the acquirers’ pre-merger slack, which was used post merger to restructure the merged firms’ capital structure.