The Governance of Regional Banks

Amid the economic recovery and the progressive unwinding of cross-shareholdings, foreign investors have been active buyers of Japanese equities, including not only shares of major banks but also of regional banks, particularly the upper-ranking ones. Among the leading 10 regional banks, the proportion of shares held by foreign investors rose from 5.6% at the end of March 2000 to 15.0% at the end of March 2005. In this paper we have confirmed, by means of panel analysis, that the capital adequacy ratio and the ratio of nonperforming loans to total loans are significant as variables determining the market capitalization of the upper-ranking regional banks. In addition, the principal components of the business performance of regional banks are extracted by using principal component analysis, a method of multivariate analysis. In this way we have confirmed that with respect to the leading regional banks there is a significant positive relationship between the principal component score and the proportion of shares held by foreign investors. As a result of the increase in the liquidity of equities, at those same regional banks a significant difference has arisen in the composition of their shareholders and the effectiveness of their governance. If the managers of regional banks conduct their management with a greater awareness of growth in market capitalization, the primary measure of corporate value from the perspective of investors, the disparities between banks will probably widen. It would be desirable for the supervisory authorities not to make a clear distinction between major banks on the one hand and regional and other banks on the other and apply a common business model to regional banks and smaller institutions, but instead to adopt a flexible posture of respecting management autonomy and utilizing market discipline.