Bank Merger Wave and Evolution of Financial System: Experience in Prewar Japan

In this paper we examined effects of bank consolidations on the financial system, using the data on the Japanese banking industry before the Second World War, when the first bank merger wave occurred. The focuses of our analysis are the governance structure and performance of banks. With respect to the governance structure, we found that consolidations had an effect of excluding the unfavorable director interlocking between banks and the related firms, especially, in the case of absorbing consolidations (the consolidation where one participant was dominant). This finding is significant, because it sheds light on the process in which "related lending" or "insider lending," pervasive in the countries in the early stages of economic development, disappears. Concerning the performance of banks, we confirmed that consolidations had a positive impact on deposit growth, while they did not have an effect to enhance bank profitability. The positive impact on deposit growth was significant for the stability of the financial system in prewar Japan, because due to the lack the deposit insurance system, the financial system was continuously exposed to the risk of bank run.