Branch Banking and Regional Financial Markets: Evidence from Prewar Japan

Based on historical bank branch-level lending and deposit data from 1920s’ Japan, we show how branch banking integrated peripheral markets with the rest of the country, with large urban banks – those headquartered in Tokyo and Osaka – using deposit supply shocks in peripheral areas to fund lending in their core markets. Faced with high-yielding lending opportunities in central prefectures, urban banks bid up deposit rates in peripheral areas, raising local banks’ funding costs and forcing them to become more effective in their screening. This competitive reallocation of capital through funding markets allowed banks to maintain a functional specialization in different customer segments and we argue that this mechanism helps explain the continued coexistence of small relationship lenders and large integrated arm’s-length lenders in local banking markets in many countries.