Haruhiko Kuroda: The role of foreign financial institutions in Japan's
financial system
Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the
International Bankers Association of Japan, Tokyo, 29 September 2014.
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Introduction
Thank you for having me at this event commemorating the 30th anniversary of the
International Bankers Association of Japan or the IBA Japan.
The IBA is a business association for foreign banks, securities firms, and other associated
financial services firms operating in Japan. Since its establishment in 1984, the IBA has been
making a substantial contribution to economic and financial developments in Japan. I
wholeheartedly honor the 30th anniversary of the IBA Japan and pay respect for its constant
efforts to date.
To start with, let me look back on the developments in the cross-border integration of
financial markets and the role foreign financial institutions have been playing during the
30 years since the IBA Japan was established. Then, I will touch on the importance of
financial system stability from a central bank's perspective, and close my speech by briefly
explaining the Bank of Japan's monetary policy management.
Financial globalization and financial system stability
The establishment of the IBA in 1984 coincided with the publication of the report by the joint
Japan-U.S. working group on the yen/dollar exchange rate, financial and capital market
issues. The report of the working group included the liberalization of, and the entry of foreign
financial institutions into, Japan's financial markets, as well as the development of the
Euroyen market in order to promote, so to speak, the opening of Japan's financial markets to the
rest of the world. In the 30 years since the publication of the report, the globalization of the
economy and the financial system has progressed significantly. With the globalization of the
financial system and the growing cross-border integration of financial markets, the role
played by foreign financial institutions in Japan has been quite significant. Many foreign
financial institutions that have started business one after another in Japan have been playing
a leading role in Japan's financial markets in various aspects, including the adoption of new
financial technologies, the development of new markets, and the introduction of advanced
risk management methods. In addition, they have played an important role in tightly linking
financial markets across borders.
The economic and financial globalization has proceeded rapidly in recent years first in
advanced economies, then involving emerging economies. Naturally, such developments are
part of the process of increasing the interdependence of financial systems in different
countries. In case there is a shock in a market, its effects will spread globally and
immediately. That suggests that financial system stability needs to be achieved on a global
basis, not in each individual country.
In fact, the global financial crisis triggered by the collapse of Lehman Brothers has made it
clear that the impact of the manifestation of a risk in globalized markets can be severe and
spread to a wide range of areas. Although Japan's financial system was relatively robust
when the crisis struck, it was not immune to the crisis. Looking back at the situation, there
was a large impact on Japan's financial markets. That included heightened concern over
counterparty risk in the money market, the distortion of pricing in financial markets due to a
liquidity shortage, and a decline in the functioning of the CP and corporate bond markets.
Unfortunately, there are not a few foreign financial institutions that had to cut back their
activities in Japan following the crisis.
Stability and functioning of the financial system
It has become a shared recognition on a global basis that, to avert the reemergence of a
financial crisis, it is important to analyze and assess the risks in the entire financial system as
well as to take adequate measures to prevent systemic risk from manifesting itself. It is the
so-called emphasis on a macroprudential perspective. Various international forums such as
the Financial Stability Board and the Basel Committee on Banking Supervision are vigorously
examining the substantial reform of international financial regulation. In line with those
developments, individual countries have been independently strengthening regulations and
substantially reviewing the supervisory system on financial institutions. One of the aspects of
a stronger macroprudential approach both on regulatory and supervisory fronts might be to
clean up individual problems that have surfaced in the process of the global financial crisis.
The cleaning up includes ensuring the soundness of individual financial institutions, solving
the too-big-to-fail problem and thereby preventing the moral hazard problem, and avoiding
taxpayers' burden in the resolution of failed financial institutions.
During the past decades, financial business has become increasingly sophisticated and
complex, financial systems have globalized, and financial markets have integrated across
borders. In this context, we should pay more attention to another aspect, to strengthen the
financial system as a whole on a global basis. Therefore, it is critical to bear in mind the
interconnectedness of financial institutions through market transactions and to gauge more
extensively overall changes in financial institutions and financial markets that compose the
financial system. On that basis, it is also critical to implement a wide range of initiatives to
maintain financial system stability.
In implementing the initiatives to enhance the stability of the financial system, we should not
ignore initiatives to enhance its functioning so that the system can firmly support sustainable
economic growth from the financial side. It appears that financial institutions' role to support
firms' innovation and growth strategy from the financial side, is only bound to become larger
in the future. Financial institutions play a variety of roles in encouraging firms' growth, such
as developing new financial products corresponding to social changes, providing efficient
settlement services and risk-hedging measures, as well as supporting M&As and
reorganizations of firms. It is extremely important for financial institutions to enhance such
roles constantly. Going forward, from a perspective of supporting Japan's economic growth
from the financial side, I strongly hope that foreign financial institutions will continue to
implement new initiatives while responding to changes in the surrounding environment.
While taking account of changes including financial and economic globalization, the Bank of
Japan will continue to make efforts to strengthen the functioning of Japan's financial markets
by enhancing payment and settlement services, including the development of the new Bank
of Japan Financial Network System, the so-called BOJ-NET, and the extension of its
operating hours, and by participating in initiatives to improve market practices, while closely
cooperating with market participants.
A macroprudential perspective for a central bank
Now, let me further talk on the issues of financial stability and a macroprudential perspective
for a central bank while taking into account their relationship with monetary policy.
Monetary policy aims at ensuring price stability and does not aim at ensuring the stability of
the financial system. However, there is a close relationship between monetary policy and the
stability of the financial system. To begin with, monetary policy has a substantial impact not
only on price stability but also on financial system stability through its effects on financial
intermediation and various asset prices. For example, central banks in advanced economies
have been pursuing ultra monetary easing through unconventional monetary policies to
achieve price stability while responding to the economic downturn after the global financial
crisis. In that situation, investment in high-risk assets such as high-yield bonds and emerging
economies' bonds and stocks has been expanding considerably against a backdrop of
declining volatility in interest rates, stock prices, and foreign exchange rates, as well as
investors' search for yields. Since the effects of monetary policy are transmitted to the real
economy through the financial system, financial system stability is the basis for monetary
policy that aims at ensuring price stability. If the functioning of the financial system declines,
the effects of monetary policy will decline to that extent. If by any chance the functioning of
the financial system is significantly impaired due to a financial crisis, it will be certain to see
an adverse impact on price stability through a plunge in economic activity.
In any event, central banks cannot be unconcerned about the stability of the financial system.
Nowadays, while a macroprudential perspective has attracted attention in the context of
regulating and supervising financial institutions, it is not at all new for central banks.
Traditionally, central banks possess the Lender of Last Resort function. While that takes the
form of central bank lending to individual financial institutions, its aim is to secure the stability
of the financial system and it is not to bail out a single financial institution. In the global
financial crisis, the Bank of Japan and other central banks responded to a rapid contraction
of the markets by providing liquidity to the markets as a whole through open market
operations, such as purchases of assets like CP and corporate bonds as well as unlimited
fund provisioning to the markets. Those responses are often called a central bank's
functioning of Market Maker of Last Resort. And it can also be said to be a policy that is
clearly associated with a macroprudential perspective. It safeguards financial system stability
through dealing not with the liquidity provision to individual financial institutions but directly
with a decline in overall market liquidity.
In considering a central bank's initiatives in a macroprudential aspect, it is often argued that
there may sometimes be a trade-off between a central bank's objectives of ensuring price
stability and ensuring financial system stability. That point has been discussed at home and
abroad and the jury is still out, but at least one can point out that history does suggest that
substantial imbalances in financial and economic activity emerge through a feedback loop in
which changes in the output gap and changes in the financial cycle reinforce each other.
That is evident when you look back on the global financial crisis and the burst of the bubble
in Japan in the 1990s. There have been many discussions on how to deal with substantial
imbalances including a bubble: to what extent such changes could be gauged in advance
and preemptive measures could be taken, or what measures should be implemented in
response to the imbalances. In any event, the recognition has become widespread that the
financial cycle could lead to significant changes in the economy as a whole. Even at normal
times, it is important to appropriately grasp the conditions of the financial system in monetary
policy management.
Analysis and assessment on risks in the financial system
Taking those points into account, the Bank examines risks in the financial system in
establishing the guidelines for monetary policy. In establishing the guidelines for monetary
policy, the Bank assesses the economic and price situation from two perspectives. The first
perspective concerns examining whether the outlook for economic activity and prices in the
coming two years or so suggests that the economy is on a path toward sustainable growth
with price stability. At the same time, the second perspective, based on a longer-term
viewpoint, concerns examining the risks that the Bank considers to be the most relevant to
monetary policy management in achieving sustainable growth with price stability. This
second perspective includes the examination of risks in the financial system as one element
of medium- to long-term risks.
Japan's financial system currently maintains stability and has substantial resilience against
shocks. Capital bases of financial institutions have been adequate on the whole, given that
the accumulation of capital has continued while the amount of risk borne by financial
institutions has increased only slightly. Developments in financial intermediation show no
indication of overheating or excessively bullish expectations. In the future, the globalization of
the economy and transformation of industrial structures could lead to changes in the financial
intermediation function and the risk profile of the financial system. In addition, financial and
economic developments at home and abroad would affect financial institutions' performance
in securities investments. The effects of various environmental changes on financial system
stability will continue to warrant attention.
Analyses that form a basis for the Bank's assessment of risks in the financial system as a
whole are semiannually published as the Financial System Report. The next issue will be
published in mid-October and I hope you will have a chance to read it.
Concluding remarks
Let me conclude by briefly touching on the Bank's monetary policy management.
Although a decline following the front-loaded increase in demand prior to the consumption
tax hike still remains and there has been some weakness in exports and industrial
production, a steady improvement in the employment and income situation has been
continuing and household sentiment has been improving. Firms have been maintaining their
proactive stance for business fixed investment as corporate profits have improved. The
virtuous cycle from income to spending has been operating steadily in both the household
and corporate sectors, and Japan's economy is expected to continue its moderate recovery
trend and the effects of the decline in demand following the consumption tax hike are
expected to wane gradually.
The year-on-year rate of change in the consumer price index, excluding volatile food and the
direct effects of the consumption tax hike, is expected to be around 11⁄4 percent for some
time. It is expected to subsequently follow an uptrend again from the second half of this fiscal
year and reach about 2 percent around the middle of the current projection period from fiscal
2014 to 2016.
Quantitative and qualitative monetary easing, dubbed QQE, has so far been producing its
intended effects. The Bank will continue with QQE, aiming to achieve the price stability target
of 2 percent, as long as it is necessary for maintaining that target in a stable manner. If the
outlook changes due to the manifestation of risk factors and it is judged necessary for
achieving the price stability target, the Bank will make adjustments without hesitation.
I have high hopes that foreign financial institutions will continue to play the significant role
they have played in Japan's economy in the past 30 years and will contribute to the robust
growth of Japan's economy in the future. With such hopes, let me conclude my speech
today.
Thank you.