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The turmoil in global financial markets also had a substantial impact on Japan’s financial markets, Masaaki Shirakawa, Governor of the Bank of Japan said. With the collapse of Lehman Brothers the situation of domestic financial markets literally changed dramatically, he said.
International banks experienced funding difficulties in the yen money market due to growing concern for counterparty risk, and the decline in market liquidity led to the distortion of pricing, or dislocation.
The responses by the Bank of Japan are classified broadly into three categories.
Ø The cut of the policy rate. The Bank lowered its target for the uncollateralized overnight call rate last October and December by 0.2 percent, respectively, to 0.1 percent.
Ø Various measures to ensure financial market stability. The substantial provision of yen liquidity and US dollar funds-supplying operations fall into this category.
Ø Measures to facilitate corporate financing. Those include the expansion of eligible collateral related to corporate debts, and special funds-supplying operations to facilitate corporate financing, which are low interest rate funds-supplying operations against corporate debts as collateral. In addition, while extraordinary for a central bank, the Bank starts outright purchases of CP from the end of this month.
Lessons for the Japanese market
It is necessary to keep remembering that a notion ‘liquidity is always there’ would not hold, Shirakawa said. As the current financial crisis has shown, liquidity could suddenly dry up.
Furthermore, it is important to establish a liquidity management system of international banks that conduct businesses at bases other than home countries. “The striking change in global financial markets after the collapse of Lehman Brothers was the decline in the functioning of not only the uncollateralized fund market but also of the foreign exchange swap market, which made it difficult to obtain funds in foreign currency, regardless of individual financial institution’s creditworthiness, he said.
Finally, the infrastructure of the market and the payment and settlement system has to be improved. The sudden collapse of Lehman Brothers brought a state of turmoil into the Japanese financial markets, Shirakawa said. The experience since the collapse of Lehman Brothers suggests the importance of a scheme to properly manage counterparty risk.
BoJ and Financial System Stability
The current financial crisis has highlighted various issues and challenges about the conduct of monetary policy by central banks, and the role of financial institution supervision and regulation, the Governor noted.
Shirakawa underlined the importance of having a macro-prudential perspective in the conduct of policies, be it monetary policy or regulation and supervision of financial institutions. “it is extremely important not only to monitor the individual risks of financial institutions or products, but also monitor the risks inherent in the financial system as a whole from a macro-prudential perspective”, he said.