Building a More Robust Financial System:
Where Are We after the Global Financial Crisis and
Where Do We Go from Here?
Speech at the DICJ-IADI International Conference
Haruhiko Kuroda
Governor of the Bank of Japan
Introduction
It is a great pleasure for me to be invited to the DICJ-IADI International Conference and to
address all of you. Thank you very much for this opportunity.
It is almost ten years since the onset of the Global Financial Crisis. At this juncture, I would
like to look back on the efforts and results at the global level with the aim of preventing the
return of the Crisis, and offer my thoughts on the challenges ahead if we are to maintain the
stability of the global financial system.
In retrospect, the Global Financial Crisis was triggered by problems in the U.S. subprime
mortgage market. Initial losses incurred by financial institutions and investors in that market
led to a severe liquidity shortage through loss of confidence among market participants.
Subsequently, following the collapse of Lehman Brothers in September 2008, we had a
full-blown crisis that destabilized the whole global financial system.
Responding to the ever worsening situation, economies around the world unleashed
aggressive macroeconomic measures, injected massive liquidity into financial markets, and
provided taxpayers' support to financial institutions, including capital injection, and these
measures prevented a contagious amplification of the Crisis. These efforts were
complemented with measures developed through international cooperation so as to prevent
the incidence of another crisis. As a result, the robustness of the global financial system has
been greatly enhanced by, for example, higher capital and liquidity reserve levels at
financial institutions, more options for liquidity provisioning by central banks, better legal
frameworks for resolving financial institutions, and enhanced communications and
cooperation among authorities.
In the meantime, many central banks in the developed economies are pursuing extremely
accommodative monetary policy, including unconventional policy measures, in order to
extricate economies from low growth and low inflation. While these measures themselves
are utterly essential responses to the conjunctural macroeconomic challenges, the resulting
"low for long" environment is eroding lending margins, which are the sources of profits for
financial institutions. Considering that financial institutions in the developed economies
have faced increasing pressures on their revenue streams, reflecting structural changes in
the financial system, the low profitability of financial institutions has become a global
problem to be reckoned with.
Building on these observations, for the rest of the time that I have today, I would like to
explain how I understand the efforts aimed at strengthening the financial system following
the Global Financial Crisis and what the remaining issues are, from three perspectives: (a)
international financial regulation, (b) macroprudential policy, and (c) the "lender of the last
resort" function of central banks. I will then conclude by offering my views on an emerging
challenge regarding the stability of the financial system; that is, the profitability of financial
institutions.
Stronger International Financial Regulations
Let me start with international financial regulations (Chart 1). In the period leading up to
the Global Financial Crisis, the financial sector, especially in Europe and the United States,
took on excessive leverage and the quality and level of capital were in decline. At the same
time, many financial institutions depended on short-term market funding, which was also a
contributing factor to the Crisis. These experiences led to the adoption of the Basel III set of
rules, the main thrust of which was to oblige internationally active financial institutions to
enhance their capital levels and to hold safe liquid assets. The final details of the framework
are still being worked out.
Furthermore, from the lesson of the dangers of moral hazard emanating from implicit public
support of systemically important financial institutions, the so-called too-big-to-fail
problem, these institutions are now required to hold additional capital to maintain total
loss-absorbing capacity (TLAC) and to draw up recovery and resolution plans (RRPs) in
case they face financial difficulties.
These enhanced rules I have just described clearly have made the global financial system
more robust. For example, looking at capital levels of financial institutions, the capital
ratios of major European and U.S. banks have increased significantly (Chart 2).
Japanese financial institutions, while they did not directly suffer much from the Crisis, also
have increased their capital levels, in line with the stricter requirements at the global level.
Under the powerful monetary easing by the Bank of Japan, they are actively taking risks in
lending and securities investment, thereby positively influencing the Japanese economy and
prices, which reflects in part their increasingly robust capital base. This clearly shows that
the stability of the financial system is essential for monetary policy to be fully effective.
Having said this, I also should stress that stronger regulation ought not to lead to excessive
restrictions on financial intermediation. As I said, details of Basel III are still being worked
out, and I recognize that the discussions should be wrapped up as soon as possible so as to
minimize uncertainties over the business environment surrounding financial institutions.
Any final agreement on the level of required capital, however, needs to balance the need to
maintain the stability of the financial system and the functioning of financial intermediation.
Keeping this in mind, the Bank of Japan will participate in the international deliberations
leading to the finalization of Basel III.
If and when there is an international agreement, the main thrust of international efforts will
turn to evaluating the effects of the strengthened rules, ensuring that such rules are working
as initially envisioned and there are no unintended consequences -- for example, whether
liquidity in financial markets is impaired as a result of stricter rules such as the leverage
ratio, and whether entities beyond the scope of regulation in the "shadow banking" sector
are expanding. In addition, it is important to review whether the whole set of rules has not
brought about overregulation or inconsistency, notwithstanding the desirability of individual
rules. Whenever it becomes apparent through these assessments that there are problems in
the rules, it is appropriate to make necessary adjustments.
Developing a Macroprudential Policy Framework
I will now move on to macroprudential policy (Chart 3). During the Global Financial Crisis,
the issue of procyclicality became evident; i.e., the interactions between the financial
system and the real economy amplifying the instability of the financial system. In response,
macroprudential policy instruments have been introduced; for example, the countercyclical
capital buffer (CCyB), which adjusts the level of required capital in accordance with the
degree of excesses in the financial system, and the loan-to-value (LTV) regulation, which
regulates the level of the minimum haircut for real estate collateral according to the state of
the real estate market.
Moreover, we also see the development of institutional frameworks for the implementation
of macroprudential policy. For example, in jurisdictions with multiple regulatory and
supervisory authorities involved in the safeguarding of financial stability, there has been
establishment of interagency committees that aim to coordinate the views of relevant
authorities, to make policy decisions, and to implement any decisions. In this regard, in
Japan, the Financial Services Agency and the Bank of Japan created the "Council for
Cooperation on Financial Stability" in 2014 and have been holding semiannual meetings
since then. In the meetings, the two authorities have been exchanging views on the state of
the financial system and financial markets, and through such interactions, the Financial
Services Agency and the Bank of Japan are reinforcing their ties regarding macroprudential
policy.
As I have just noted, we are now seeing the development of macroprudential policy tools
and institutional frameworks, but ensuring effective and timely implementation of policy
measures in real life would be challenging. For that to happen, supervisory authorities and
central banks must first be able to properly observe the signals that point to excessive
activity or inactivity in the financial system. Once moving into action, there are still
unresolved issues, such as the following: the lag between the imposition of measures and
the manifestation of the effects of those measures; leakage of the effects into sectors that are
outside the scope of macroprudential measures; and the necessity of taking into account
other public policy areas, such as residential tax policy, in the case of the real estate market.
All in all, the effects of the newly introduced macroprudential policy measures have not
been fully verified, and we need to enhance our understanding through application and
review.
In any case, supervisory agencies and central banks charged with macroprudential policy
must make every effort to improve their analyses of macro-level risks in the financial
system and be on the lookout for any symptoms of financial instability evident in the
activities of individual financial institutions. In this regard, the Bank of Japan will be
enhancing its micro- and macro-level diagnostic capabilities through its on-site
examinations and off-site monitoring of financial institutions and analyses published in the
Financial System
Report.
A New Horizon for the "Lender of the Last Resort" Function
As the third perspective regarding developments since the Global Financial Crisis, I would
like to touch upon the "lender of the last resort" function of the central bank (Chart 4).
Traditionally, the "lender of the last resort" function of the central bank has been a tool to be
used when systemic risk manifests itself through contagion; in other words, the
deteriorating health of one financial institution tainting other financial institutions through
inferences made by depositors and/or links in payment networks. Generally, it was regarded
as an operation to provide domestic currency funding to "solvent but illiquid" financial
institutions.
In contrast, during the recent Global Financial Crisis, systemic risk manifested itself in a
different way: increasing concerns over counterparty risk among market participants
resulted in a dramatic contraction of market activities. In response, central banks of major
economies injected liquidity to financial markets through purchases of commercial paper
and corporate bonds, and thus supported the continued functioning of markets. In this
regard, the "lender of the last resort" function of central banks morphed into something
broader by incorporating the "market maker of the last resort" function.
Meanwhile, it also became evident during the Crisis that liquidity shortages in foreign
currencies -- for example, resulting from the freezing of the currency swap market -- were
extremely problematic, as the expanding global reach of financial institutions promoted
financial intermediation in foreign currencies. Accordingly, in 2007, the European Central
Bank and the Swiss National Bank each entered into a swap arrangement with the U.S.
Federal Reserve, enabling the two European central banks to supply U.S. dollar funds to
financial institutions in their jurisdictions. After the collapse of Lehman Brothers, the Bank
of Japan, the Bank of England, and the Bank of Canada also entered into swap
arrangements with the Federal Reserve, and in 2011, the individual arrangements evolved
into a multilateral arrangement covering not only U.S. dollars but also other major
currencies. One can say that, with the development of such a multilateral swap arrangement
to supply foreign currency liquidity, the "lender of the last resort" function has developed
into a "global lender of the last resort" function.
This quick overview shows that the central bank is playing a bigger role with its "lender of
the last resort" function. It could be safely said that we now have a more robust backstop as
regards liquidity provision in the major currencies during market turmoil. The challenge
ahead is to devise frameworks to deal with the case where a financial institution with a
global reach faces foreign currency liquidity shortages for idiosyncratic reasons and the
case involving non-major "local" currency liquidity shortages. For the Bank of Japan,
potential systemic instability caused by shortages of foreign currency liquidity is an issue
that requires prompt attention, in view of the fact that Japanese financial institutions are
expanding their global businesses, including in Asia, while these institutions are still
broadly enjoying good access to foreign currency funding.
Reflecting on these challenges, the Bank of Japan has decided to provide U.S. dollar
liquidity to individual banks facing temporary dollar funding difficulties utilizing the Bank's
U.S. dollar-denominated assets. As to local currencies, the Bank established swap
arrangements for Australian and Singaporean dollars with the respective central banks last
year, which should enable the Bank to supply Australian and Singaporean dollar liquidity
secured through these arrangements to Japanese financial institutions facing funding
difficulties in these two currencies. Though the Bank must be careful in avoiding moral
hazard at financial institutions, it will continue to develop backstop frameworks for foreign
currency funding in conjunction with relevant authorities.
The New Challenge of Low Profitability at Financial Institutions
As we have seen today, much has been learned from the Global Financial Crisis and various
measures have been put in place to prevent the return of the Crisis. While there are still gaps
to be filled in every area, I should say that the global financial system has become
significantly more robust than before the Crisis.
However, this does not mean that there are no more areas that require attention regarding
financial stability. Over the longer term, it is becoming important to cope with the potential
risk of low profitability at financial institutions eroding financial stability.
Faced with low growth and low inflation in the years following the Global Financial Crisis,
many central banks of major economies adopted extremely accommodative monetary policy,
including unconventional measures. As I noted at the beginning, such a policy stance itself
reflects macroeconomic necessity, but the resulting plunge in nominal interest rates is
negatively impacting profits at financial institutions through compression in interest rate
margins.
At this very moment, financial institutions around the world are still reporting respectable
levels of profits, benefiting from lower credit costs in an improving economy and increased
profits from selling securities for which prices appreciated as interest rates fell. Having said
this, if the low interest rate environment persists, interest rate margins will be further eroded
and the profitability of financial institutions will suffer as a result. In Japan, for example,
financial institutions face structural headwinds including an aging and decreasing
population (Chart 5). In Europe, low profitability is regarded as a risk to financial stability
in the context of a non-performing loans problem at some financial institutions. This shows
that the problem is more or less global.
There are various channels through which low profitability at financial institutions could
adversely affect financial stability. One channel is the inability of financial institutions to
accumulate sufficient capital due to low profitability. That would heighten the risk of banks'
capital being eroded when large credit losses occur or when securities investments incur
large losses in a volatile market. With thin capital buffers, financial institutions could
become too risk averse and not effectively perform their function as intermediaries. On the
other hand, if financial institutions try to avoid such a predicament by taking excessive risks
to increase revenues, such actions themselves would introduce new sources of instability to
the financial system. All in all, in order for the financial system to ensure future stability, it
is becoming more and more important in the long term to think about possible responses to
low profitability at financial institutions.
The starting point would be to have individual financial institutions accurately recognize the
business environment that they are in, and formulate business models that appropriately
take account of the environment. Financial institutions have a range of options and can, for
example, step up efforts to find new SME and household lending opportunities, take risks in
the securities markets, strengthen fee-collecting business lines, and cut costs including
extensive restructuring of the branch network. Individual financial institutions must choose
approaches that are best suited to their individual needs. In some cases, mergers or
consolidation between financial institutions could be an option.
In order for financial institutions to enhance profitability, authorities would play an
important role. In that context, given that the business environment of each financial
institution is different, and that forward-looking responses regarding the changing
environment are essential, it may not be appropriate to adopt one-size-fits-all regulatory
measures. Instead, a "soft" approach through supervision and guidance may be more
effective in encouraging financial institutions to apply individually tailored solutions. In
view of this, the Bank of Japan, through its on-site examinations and off-site monitoring,
aims to encourage financial institutions to step up their risk management efforts in areas
where the institutions are taking on increasing risk, and to deepen discussions with
institutions regarding profitability enhancement. In addition, the Bank will actively support
the efforts of financial institutions through the hosting of seminars targeted at enhancing the
value of financial services.
Concluding Remarks
Today, I have taken a look at the efforts and results at the global level in aiming to prevent
the return of the Global Financial Crisis, particularly in terms of policy areas that are
closely related to the role of the central bank. Specifically, these are international financial
regulation, macroprudential policy, the "lender of the last resort" function of central banks,
and low profitability at financial institutions. Of course, I must admit that this is not the
whole story: laws and regulations to deal with a failure of systemically important financial
institutions have been greatly improved, and the international cooperative framework for
crisis management has been significantly strengthened. In the meantime, deposit insurance
schemes, which will be extensively discussed at this conference, now insure higher amounts
under strengthened financial foundations, thereby contributing significantly to a more
robust financial system.
All in all, over the last ten years or so, the robustness of the global financial system has
been steadily enhanced in many areas. Accordingly, the risk that we could fall into the same
kind of crisis as the last one is probably lower to a considerable degree. Having said that, I
must point out that the environment surrounding the financial system is undergoing rapid
changes, including the development of FinTech and the rapid growth of the shadow banking
sector. In addition, as I just noted, a new challenge has emerged in the form of low
profitability at financial institutions. These developments suggest that a different kind of
financial crisis could happen in the future. There will always be room for efforts to enhance
the stability of the financial system, and authorities must continue to respond to changes in
the environment.
Fortunately, we now have a framework for global cooperation built up during the ten years
since the Global Financial Crisis, and that framework was successfully applied to enhance
the robustness of the financial system. There will be challenges ahead, but we are prepared
to meet them with confidence.
Thank you for your attention.
Building a More Robust Financial System:
Where Are We after the Global Financial Crisis and
Where Do We Go from Here?
Speech at the DICJ-IADI International Conference
February 16, 2017
Haruhiko Kuroda
Governor of the Bank of Japan
Chart 1
International Financial Regulations
Dealing with the "too-big-
Basel III
to-fail" problem
Strengthening the quality and
Improving risk coverage
quantity of capital (numerator)
(denominator)

Additional capital charge for G-
✔
Quantity: introducing the Common
✔
Interest rate risk in the
SIBs (G-SIB surcharge)
Equity Tier 1 capital and raising the
banking book
minimum requirement
✔
Credit risk
✔

Quality: adopting a stricter definition Effective bank resolution
✔
Operational risk
of bank capital
framework for G-SIBs

Development of legal
Bank capital
Regulations on
=
Capital ratio framework
large exposure
Risk-weighted assets

Establishment of recovery and
Supplementary tools:
resolution plans (RRPs)
three new regulatory measures

Introduction of total loss-
Leverage ratio
Liquidity measures
requirement
absorbing capacity (TLAC)
✔
Liquidity coverage ratio (promoting the
short-term resiliency under stressed scenario)
✔
Net stable funding ratio (securing stable
funding structure for long-term investments)
Chart 2
Capital Adequacy of Financial Institutions
in Major Countries
Japan United States Europe
%
% %
18
18 18
16
16 16
14
14
14
12
12 12
%
10
10
18 10
8
8 8
16
6 6
6
14
4 4 4
12
CY08 09 10 11 12 13 14 15
FY08 09 10 11 12 13 14 15 CY08 09 10 11 12 13 14 15
10
8
Tier 1 capital ratio Common equity Tier 1 capital ratio
6
4
FY08 09 10 11 12 13 14 15
Notes: 1. Figures for Japan are weighted averages of internationally active banks.
2. Figures for the United States are simple averages of five U.S. banks (Bank of America Merrill Lynch, Citi, Goldman Sachs, J.P. Morgan, and Morgan Stanley).
3. Figures for Europe are simple averages of six European banks (Barclays, BNP Paribas, Credit Suisse, Deutsche Bank, HSBC, and UBS).
Sources: Bank of Japan; Bloomberg.
Macroprudential Policy
Macroprudential policy tools
✔
Countercyclical capital buffer (CCyB)
✔
Loan-to-value (LTV) regulation, etc.
Institutional frameworks for the implementation of
macroprudential policy
✔
Establishment of interagency committees in jurisdictions with multiple regulatory and supervisory
authorities, etc.
✔
Creation of the "Council for Cooperation on Financial Stability" in Japan
A New Horizon for the "Lender of Last Resort" Function
The traditional "Lender of Last Resort" function
✔
Responding to the risk of the deteriorating health of one financial institution tainting other
financial institutions through inferences made by depositors, etc.
"Market Maker of Last Resort" function
✔
Responding to the contraction of market activities resulting from concerns over counterparty
risk among market participants
"Global Lender of Last Resort" function
✔
Responding to foreign currency liquidity shortages faced by globally active financial institutions
Chart 5
Core Profitability of Japanese Financial Institutions
Lending margins Operating profits from core business
Major banks Shinkin banks
Regional banks
Second half of
tril. yen
tril. yen
tril. yen
%
the fiscal year
1.0
3.0 4.5 2.5
Major banks
First half of the
Regional banks 4.0
fiscal year
0.8
2.5 Shinkin banks 2.0
3.5
3.0
2.0 0.6
1.5
2.5
2.0
1.5 0.4
1.0
1.5
1.0
1.0 0.5 0.2
0.5
0.5 0.0 0.0 0.0
FY04 06 08 10 12 14 FY
89 91 93 95 97 99 01 03 05 07 09 11 13 15 FY 89 91 93 95 97 99 01 03 05 07 09 11 13 15 FY 89 91 93 95 97 99 01 03 05 07 09 11 13 15
Source: Bank of Japan.