in sales. this indicates not only the cyclical strengthening of the economy but also the strengthening of the corporate structure accompanying progress in dealing with structural problems. problems in the financial system although there are still more than a few problems left for banks to deal with, they have made substantial progress in dealing with npl problems over the past year or so. major banks have made considerable progress in disposing of npls, although the pace of disposal has varied across individual institutions. combined with the rise in stock prices, their capital adequacy ratios recovered, on average, to around 11 percent at the end of september 2003. regional banks have also made progress in reducing npls, but the pace of disposal has been slower than at major banks. under such circumstances, banks ’ lending attitude seems to be gradually becoming more accommodative. the lending attitude as perceived by firms in the tankan has improved moderately. in the most recent march survey, the number of firms that responded that banks ’ lending attitude was “ accommodative ” exceeded those that responded “ severe. ” the bank intends to encourage these favorable developments. japanese banks need to realize that they will no longer be able to satisfy the diverse needs of their customers simply by increasing the supply of conventional bank loans. as a matter of fact, it is encouraging that a considerable number of banks have already launched initiatives toward introducing new methods of credit extension, expanding existing channels for credit extension, managing their credit portfolios proactively, and developing more sophisticated risk management systems. the bank will back their efforts to establish new business models, as stated in its “ on - site examination policy for fiscal 2004. ” the full removal of blanket deposit insurance in april 2005 will be an important challenge for banks, as it will put their true financial strength to the test. the bank hopes that efforts such as those i have described will enable many banks to regain market confidence and allow them to meet this challenge on their own. the situation in the household sector finally, let me turn to the household sector. consumers have been rather restrained in their spending as they have experienced prolonged economic stagnation and the frequent emergence of concerns over financial system stability. recently, however, there have been signs that consumers ’ attitude has become somewhat less restrained. for example, the growth rate of the amount outstanding of banknotes in circulation has been slowing recently. in the past, the growth in banknotes surged when major financial institutions failed in 1997 and 1998 or when blanket deposit

economic downturn has not significantly eroded the capital of most financial intermediaries, and the terms and availability of credit have not tightened to such an extent as to be significant factors in deepening the contraction or impeding the recovery. the use of a growing array of derivatives and the related application of more - sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial intermediaries. derivatives have permitted financial risks to be unbundled in ways that have facilitated both their measurement and their management. because risks can be unbundled, individual financial instruments now can be analyzed in terms of their common underlying risk factors, and risks can be managed on a portfolio basis. concentrations of risk are more readily identified, and when such concentrations exceed the risk appetites of intermediaries, derivatives can be employed to transfer the underlying risks to other entities. as a result, not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient. individual institutions ’ portfolios have become better diversified. furthermore, risk is more widely dispersed, both within the banking system and among other types of intermediaries and institutional investors. even the largest corporate defaults in history ( worldcom and enron ) and the largest sovereign default in history ( argentina ) have not significantly impaired the capital of any major financial intermediary. likewise, record amounts of home mortgage refinancing and accompanying declines in mortgage asset durations have not imperiled the principal intermediaries in the mortgage markets, in substantial part because these institutions were able to use derivatives to transfer a significant portion of the convexity risk associated with prepayments of fixed - rate mortgages to investors in callable debt and issuers of putable debt. risks associated with the use of derivatives if derivatives and the techniques for risk measurement and management that they have facilitated have produced all these benefits, why do they remain so controversial? the answer is that the use of these instruments and the associated techniques pose a variety of challenges to risk managers. inevitably, risk - management failures occur, and in two instances - - the highly publicized cases of barings and long term capital management - - they proved destabilizing. those that question the net benefits of derivatives see daunting risk - management problems and thus foresee catastrophic outcomes. in particular, they fear that common deficiencies in risk management will result in widespread failures or