partly because japanese financial institutions had to divert much of their energy to the disposal of nonperforming loans, a burden created by the bursting of the economic “ bubble. ” it is also attributable to the conventional frameworks of the japanese financial markets and the financial system, which have been left unchanged despite the rapidly changing financial environment, making it difficult to develop and introduce new financial instruments and services. globally, the most conspicuous change in the financial markets in recent years has been the rapid progress in financial innovations, reflecting the development of computer and communications technology. new financial instruments such as derivatives and securitization have made it possible to unbundle risks - namely, credit risk, interest rate risk, and foreign exchange risk - of conventional - 6financial instruments such as loans and bonds, and trade these risks individually or as various combinations of risks. the risks traded through the new financial instruments are no different from those originally incorporated in the conventional financial products. however, the range of services that financial institutions can provide has expanded significantly as it has become possible to trade only the risks without paying for or delivering the underlying asset. conventional financial services, for example, focused on the flow of funds, that is, investment and financing, of firms and households. in comparison, recent financial services place greater emphasis on analyzing the overall risks of the assets and liabilities of firms to hedge those risks or to take new risks. the services can thus be elaborately tailored to the specific financial conditions of individual customers. in other words, it has become possible for firms and households to manage their portfolios efficiently and more flexibly by utilizing custom - made services based on advice from financial institutions. the words derivatives and securitization may sound irrelevant to households, but they have in fact increased opportunities for households to efficiently manage their assets and liabilities, by expanding the range of assets in which pension trusts and investment trusts can be invested indirectly through institutional investors, and by increasing the range of instruments which can be accessed directly by households. along with the progress in financial innovations, advances in computer and communications technology are further promoting financial globalization. today, firms and institutional investors around the world are not only transferring funds frequently across borders, but are also accessing financial markets worldwide on a daily basis in pursuit of the best means to control risk. in terms of technical capability at least, by utilizing computer networks, even firms that are small in scale can solicit funds directly from overseas investors and individuals can deal directly

mr. matsushita comments on recent monetary and economic conditions in japan and the reform of the financial markets speech given by the governor of the bank of japan, mr. yasuo matsushita, at the kisaragi - kai meeting in tokyo on 14 / 4 / 97. i. introduction i am greatly honored to have been invited today to address this distinguished audience. i would like to take this opportunity to first discuss recent monetary and economic conditions in japan and issues regarding the financial system. i would then like to discuss the bank of japan ’ s views on financial market reform in japan, the subject of heated discussion since prime minister hashimoto proposed the “ big bang ” deregulation package for japan on november 11, 1996. the financial markets constitute the infrastructure supporting a nation ’ s economy, and thus their efficient and stable functioning is essential to the promotion of unhindered economic growth in the long term. accordingly, market reform has become an urgent issue in japan, as the financial markets seem to be losing international competitiveness. however, various arguments are being heard on the pace and the potential side effects of the reform. bearing these arguments in mind, i wish to return to the basics of market reform and discuss why a reform is currently needed in japan and the approach to be taken in promoting the reform. ii. recent monetary and economic conditions in japan a. the strength of economic recovery i would like to start by examining the strength of the self - sustained economic recovery over the past several years. according to the economic planning agency, the current economic recovery began in october 1993, and has continued for about three and a half years. the recovery, however, has not been constant, and therefore, many people may not have been able to appreciate the true strength of the recovery. in fact, the growth rate of the economy remained low at around 1 percent even after 1993, and there were concerns about the occurrence of a deflationary spiral at one time in 1995. this extremely slow pace of economic recovery was due to the fact that the japanese economy had to overcome various structural adjustment pressures - that is, pressures to reduce the burdens created by the bursting of the economic “ bubble ” and pressures to adapt to a new global economic environment. since 1996, however, the recovery in real economic activity has finally become evident. looking at gdp growth in 1996, the contribution of fiscal expenditures, which had been large at the beginning of the year, gradually decreased. at the same time,