hirohide yamaguchi : challenges for japan ’ s financial system after the financial crisis speech by mr hirohide yamaguchi, deputy governor of the bank of japan, at the symposium co - hosted by the university of tokyo and development bank of japan, tokyo, 10 december 2010. * * * introduction it is my great honor to have an opportunity to speak at a symposium co - hosted by the center for advanced research in finance, the university of tokyo, and the research institute of capital formation, development bank of japan. while the global financial crisis that erupted about two years ago, triggered by the failure of lehman brothers has not been completely over, the situation has significantly improved. progress has also been made in establishing an international framework for preventing the recurrence of the recent global crisis in the future. meanwhile, japan ’ s financial system has been relatively stable, compared with that in the united states and europe, but some challenges have become clear as the effects of the crisis reached here in various forms. in those circumstances, it is indeed topical to discuss today how the future of japan ’ s financial system should be, and i am looking forward to the discussions by the experts. for my part, i will briefly review the financial crisis and talk about the future of japan ’ s financial system and challenges for japanese financial institutions. i. global financial crisis and japan ’ s financial system a. the international financial system after the lehman shock these two years following the failure of lehman brothers have been indeed a tumultuous period for the global economy and the international financial system. following the failure of lehman brothers, a financial crisis erupted on a global scale, and the global economy deteriorated simultaneously and rapidly. subsequently, due to the effects of exhaustive policy responses by the governments and central banks, the global economy gradually started to recover around the spring of 2009 and profits and funding conditions of major u. s. and european financial institutions improved significantly. however, against a backdrop of european fiscal problems including those in greece and ireland as well as heightened uncertainty about the future of the u. s. economy, there have been phases in which financial markets have become unstable again since the spring of 2010. in the united states and europe, amid continued balance sheet adjustments, bank lending has been sluggish and credit costs have been somewhat at high levels. the international financial system is still in a fragile state. b. effects on japan ’ s financial system looking at the impact of the global financial crisis on japan ’

s financial system, there was relatively a large decline in the functioning of cp and corporate bond markets. on the other hand, the direct impact on financial institutions central to japan ’ s financial intermediation remained relatively small, compared with that on u. s. and european financial institutions, and the stability of the financial system as a whole was maintained. three reasons can be pointed out. first, and probably the major reason, was that japanese financial institutions had been generally cautious about taking risks based on the experience of the financial crisis since the 1990s. specifically, their investments in complex financial products such as collateralized debt obligation had been low and they had not adopted, unlike major u. s. and european financial institutions, the originate - to - distribute business model in a full - fledged manner. second, in terms of incentive, there was relatively low pressure from shareholders who pursued short - term returns and the remuneration system of financial institutions ’ managers was also not conducive to short - term risk - taking activity. third, as a result of the efforts by the public authorities to enhance the robustness of the financial system, including an establishment of a resolution framework for financial institutions, concern about the surfacing of systemic risk did not heighten among depositors and market participants. nevertheless, the global financial crisis has also affected japan ’ s economy in various forms such as a deterioration in economic activity, a fall in stock prices, and a decline in market functioning. japanese financial institutions have also been hit accordingly in the form of impairment due to a decline in stock prices and of an increase in credit costs. in the meantime, the challenges japanese financial institutions have been faced with, such as the weakness of core profitability and vulnerability against stock price fluctuations, have been highlighted again. i will come back to the details later. ii. prospects for japan ’ s financial system a. changing environment surrounding japan ’ s financial system the topic of today ’ s panel discussion is “ whither the financial system? ” it is quite a difficult question, but in the hope of providing some reference to the discussion, i offer some consideration of how japan ’ s financial system should be after the financial crisis both from macro and micro perspectives. as it might be useful to consider first what changes are expected in the environment surrounding japan ’ s financial system in the future, let me start with the following three points. strengthening of global regulation and supervision first, financial regulation and supervision will be strengthened on a global basis. on