12 March 2008

BoJ warns against potential financial system imbalances

The Bank of Japan warns in its latest Financial System Report that potential imbalances jeopardizing the stability of the financial system following the US subprime market had been growing. “Japan's financial system, on the whole, has remained stable”, the BoJ notes. “At present, the U.S. subprime mortgage problem is unlikely to jeopardize the stability of Japan's financial system.”

“Japanese financial institutions have contained losses stemming from the U.S. subprime mortgage problem within their current profit levels and capital strength, although such losses have increased as the problem has become serious”, the BoJ states. “Financial institutions need to properly gauge and manage the risk-return profiles of alternative investments as well as changes in such profiles.”

The BoJ draws two main lessons and challenges for the financial systems based on the U.S. subprime mortgage problem:

- First, the multi-layered securitization intensified leveraging and undermined incentives for risk assessment.

- Second, financial institutions - intermediaries responsible for distributing risks - need to assess and manage risks properly. At the same time, market infrastructure needs to be further developed so as to enable a wide range of investors - agents assuming risks - to collect and evaluate information pertaining to risks, thereby promoting the effective functioning of market discipline.

Press release

Financial System Report

© Graham Bishop