The Effect of Bank Credit on Asset Prices: Evidence from the Japanese Real Estate Boom during the 1980s

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This paper studies whether bank credit fuels asset prices. The Japanese real estate boom during the 1980s provides a unique episode to help answer this question. In particular, this paper studies to what extent an exogenous shock to the supply of bank credit contributes to fuelling land prices. The decline in banks' loans to keiretsu firms beginning in the early 1980s is used as the shock to bank real estate credit. It is first shown that the evidence supports the Hoshi and Kashyap hypothesis and using keiretsu loans is a legitimate instrument. Financial deregulation allowed keiretsu firms to obtain finance from public markets and reduce their dependence on bank credit. Therefore it was a choice by firms to move away from banks. In contrast, there is no support for the good opportunities hypothesis, which would imply that banks chose to move away from keiretsu firms to real estate because of perceived good opportunities. The main part determines that banks that lost these blue-chip customers increased their real estate lending, and that increase drove up land prices. This is shown in two ways and takes advantage of the cross-sectional and time-series variation in Japan's 47 prefectures. First, those prefectures that experienced a larger loss in their banks' proportion of keiretsu loans experienced a larger increase in real estate lending which fuelled land inflation. An increase of 0.01 in a prefecture's instrumented real estate loans as a share of total loans implies a 14-20% higher land inflation rate over the 1981-1991 period. Second, the timing of losses coincides with the subsequent land inflation. From 1983 to 1993 and based on the fixed effects model, the average predicted land price inflation coming from instrumented real estate lending is close to the Japan-wide average land price inflation during this period, 6.4 percent annually.