Last Friday, Bank of Japan Governor Masaaki Shirakawa, during a speech at the annual meeting of the Bank for International Settlements in Basel, Switzerland expressed uncertainty as to whether ongoing efforts to reform the financial and regulatory system would create a framework to prevent a future crisis from taking place. Governor Shirakawa, questioned specifically whether “legally effective netting contributed to reducing the overall degree of risk in the financial system” and whether going forward financial institutions would adopt different business strategies that would not seek to expand their leverage when “fac[ed] again [with] a benign economic condition.” He also addressed monetary policy responses to a bubble and warned against increases in regulatory capital, essentially on the ground that such measures would prove unworkable. His warning, however, is at odds with the view in most G-20 counties that capital adequacy standards should be strengthened.

Governor Shirakawa stated that while some financial institutions would most likely adopt a “conservative strategy, considering the lessons from the past,” he noted that “most financial institutions will find it hard to resist pressures from equity holders to raise the returns on equity under severe competition.” Governor Shirakawa, emphasized that policymakers should analyze the “incentives of financial institutions from the viewpoints of the marco-as well as micro-level.”

Governor Shirakawa noted that in formulating monetary policy it is important that financial institutions “play an important role as a mediator in transmitting the effects of monetary policy.” He also noted that central banks should approach the financial crisis by determining how monetary policies “should be conducted in an environment in which all the symptoms of the economy except for inflation signal a need for policy tightening … when only inflation remains low.” Governor Shirakawa pointed out that policymakers should adopt and develop “prudential policy measures.” In his closing remarks, Governor Shirakawa emphasized that regulation should also focus upon issues at the micro level. He cautioned that “one-size-fits-all treatments of heterogeneous financial institutions in designing prudential regulation, such as capital adequacy regulation and liquidity regulation, entail a risk of deteriorating the robustness of the financial system.”