. therefore, with a view to enhancing the soundness and efficiency of management, an increasing number of financial institutions are strengthening their risk management and attaching more importance to profitability in their extension of loans. these efforts by financial institutions are indispensable for strengthening japan ’ s financial system. however, it is a matter of concern whether the cautious lending attitude of financial institutions has reached the point where it hinders the recovery of the economy as a whole. to date, partly because of weak corporate demand for funds, there has been neither any significant shortage of funds in corporate financing nor an overall rise in lending rates due to a squeeze in lending. therefore, the bank believes that the cautious lending attitude of financial institutions is not hampering economic recovery at present. however, risk management systems of financial institutions are being further reinforced. in addition, the influence of developments in financial markets, such as low stock prices and the rise in the “ japan premium ”, on financial institutions ’ lending activity requires due attention. while the current lending activity of financial institutions is not hampering economic recovery, it is not positively contributing to the recovery as it did during past periods of monetary easing. this fact offers a significant point for discussion when considering the interaction between financial activity and real economic activity, because the expected role of financial institutions goes beyond merely responding passively to corporate demand for funds. financial institutions are expected to actively support forward - looking business activities - - for example, by helping corporations find new business opportunities and accepting financial risks when new businesses are started. in fact, such functions of financial institutions played a significant role in promoting economic recovery in the past. while it is true that financial institutions went too far in these activities, leading to the emergence of the economic “ bubble ”, it is also undeniable that in the present phase of economic recovery financial support for economic activity has been weak. in order to ensure economic recovery, it is important to strengthen the functions of financial institutions and the financial market, thereby restoring a strong and efficient financial system. i would like to point out that the cautious lending attitude of financial institutions, causing the so - called “ credit crunch ”, should therefore be discussed in connection with the issue of strengthening the financial system. c. the significance of stronger confidence in the economy the bank ’ s primary concern regarding the economy is the fact that the confidence of firms and households in the japanese economy and its outlook seems to be deteriorating. it is very difficult to measure accurately the level of confidence

the situation. in the adjustment process, the exchange rate may overshoot, giving the impression that the market is in disruption. however, it is important that the grounds for such large fluctuations be clearly identified, or otherwise, the warning signals sent out by the market, which are pointing to the expanding gap in this case, will be overlooked. with the emergence of the asian currency turmoil, some have questioned the previous achievements of east asian economies. this view also seems to be rather extreme. it appears that the potential growth rate of east asia remains high, supported by its high - quality labor, high savings rate, and solid market and industry infrastructures. although east asian economies will face adjustment pressures in the short term, they can be expected to establish a foundation for further growth by carrying out various structural reforms based on their recent experiences. what, then, can be considered to be the background of the recent turmoil in asian currencies? while asian countries differ from each other in many ways, one common factor is that most asian currencies were pegged to the u. s. dollar, and under the peg, large amounts of foreign funds flowed in during the 1990s. this in turn led to excessive financial and investment activities, overheating of the economy, and accordingly, deterioration in the external balance. it cannot be denied that there was a sense of euphoria, or an overexpectation of economic growth, in east asia. when there is an influx of abundant funds based on such expectations, upward pressure is exerted on the foreign exchange rate of the country ’ s currency. to maintain the pegged exchange rates, countries were under pressure to ease money to lower domestic interest rates or at least avoid monetary tightening. such policy response fuelled financial and investment activities, and this may have upheld the euphoria for a certain period of time. inflation rates in asian countries rose due to overheated economic activity, and under their fixed exchange rate system, their currencies became overvalued. consequently, the international competitiveness of these economies declined gradually and current account deficits expanded. the deficits in the current accounts were not a problem as long as they were financed by foreign capital. however, as soon as market participants began to doubt the sustainability of the external imbalance and the economic boom in the area, foreign funds were abruptly withdrawn from the countries, putting severe pressures on foreign exchange rates and stock prices. against this backdrop, many countries were compelled to abandon