Health of Japan's Financial System Tied to Growth, Government Debt and Deficits

Policies after crisis in 1990s, early 2000s helped secure financial stability

Risks to financial sector from large exposure to government bonds, slow economic growth

Reforms essential to improve credit growth

Deep-rooted issues need to be addressed that pose risks to financial stability: long-term fiscal sustainability, deflation, and the impact of the country’s aging population on growth and private savings, the International Monetary Fund said in its latest assessment of the country’s financial system under the Financial Sector Assessment Program.

Swift and decisive policies have helped maintain financial stability, including in the wake of the earthquake and tsunami in 2011, but Japan needs to strengthen systemic risk monitoring and crisis management policies, and further reform the oversight and supervision of nonbank financial institutions.

“Japan is a prime example of how a country’s overall economic health and its financial system are so closely connected,” said Udaibir Das, an Assistant Director in the IMF’s Monetary and Capital Markets Department and head of the team that conducted the assessment. “A broad-based plan for financial reform could help Japan create an environment that enables private sector-led growth alongside an ambitious, multi-year reduction in government debt and deficits. Our assessment has offered a number of ideas to strengthen micro-and macro-prudential oversight, and called for financial reforms to gradually reduce the role of the government in the credit channel.”

Changes in financial system helped weather global crisis

Japan is one of the major 25 financial centers that since 2010 are required to undergo an in-depth review of their financial health every five years under the Financial Sector Assessment Program as part of the IMF’s surveillance. Japan’s last assessment was in 2002.

Since 2003, large banks and insurance companies have restructured to improve financial soundness, reduced nonperforming loans, and strengthened their capital positions considerably. Also, Japan enhanced its oversight and regulation of the financial system, and greatly improved its ability to manage banking crises. As a result, the system was able to weather the global economic crisis that began in 2008, and is well positioned to implement the new international banking standards, known as Basel III.

“It is remarkable that Japan’s financial system could withstand so well one of the most severe output contractions...