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Outline of Financial System Stability

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Outline of Financial System Stability

Money plays an indispensable role in economic activities.  The overall structure of receipt and payment as well as lending and borrowing of money is called the financial system.  The financial system is composed of various financial markets and numerous financial institutions.

Maintaining financial system stability and price stability are the two main objectives of the Bank. "Financial system stability" refers to a state in which the financial system functions properly, and participants, such as firms and individuals, have confidence in the system.

To contribute to the maintenance of financial system stability, the Bank conducts on-site examinations and off-site monitoring, and acts as the lender of last resort to provide liquidity when necessary.

The Bank's Initiatives at the Microprudential Level: On-Site Examinations and Off-Site Monitoring of Financial Institutions

Maintaining the sound management of financial institutions is an important prerequisite to ensure financial system stability, as they play a number of important roles.  They serve, for example, as part of payment and settlement systems for the transfer of funds and securities.  They also serve as financial intermediaries to allocate funds and risks among individuals and firms by receiving funds from depositors and extending loans or buying securities with the received funds.

The Bank assesses the condition of business operations, risk management, capital adequacy, and profitability of financial institutions that hold current accounts at the Bank (BOJ account holders), such as banks and securities companies, and encourages them to maintain and improve sound management.  To understand their condition, the Bank conducts on-site examinations and off-site monitoring.  In on-site examinations, examiners of the Bank visit financial institutions, whereas off-site monitoring is conducted through meetings and telephone interviews, and through analysis of various documents submitted by BOJ account holders.

Moreover, the Bank encourages a wide range of efforts by financial institutions to improve their management of risks and business operations, by hosting open seminars and releasing research papers (see the Center for Advanced Financial Technology for details).

Risk Analysis and Assessment of the Overall Financial System: A Macroprudential Perspective

In order to achieve financial system stability, it is important to base the Bank's policy measures not only on a microprudential perspective, which evaluates risks specific to each financial institution to further improve their business operations, but also on a macroprudential perspective, which analyzes and assesses the risk profile of the financial system as a whole.  The Bank has been employing both micro and macro perspectives in its risk analysis and assessment, publishing the findings in the Financial System Report and reflecting them in monetary policymaking (for details, please see the Financial System Report).

Provision of Emergency Liquidity to Maintain an Orderly Financial System

The Bank's effort in analyzing and assessing risks from both micro and macro perspectives alone may not be sufficient to prevent systemic risk from materializing.  The term systemic risk is used to describe the possibility that the bankruptcy of a financial institution or disruptions in a particular market or payment and settlement system will pose risks to other financial institutions, other markets, or ultimately the entire financial system, through a chain of disruptions or dysfunctions.  The Bank, when necessary, acts as the lender of last resort to maintain an orderly financial system and provides funds to financial institutions experiencing a temporary shortage of funds.  As part of the liquidity provision function, the Bank may extend uncollateralized loans, pursuant to Article 38 of the Bank of Japan Act, and such loans are referred to as "Tokuyu (a special loan)."

International Cooperation

International cooperation has become even more important in achieving financial system stability as financial markets globalize further.  The Bank has been working in cooperation with relevant central banks and supervisory authorities abroad on issues concerning financial systems, and also participates actively in discussions at international forums that review regulatory frameworks, aimed at strengthening the global financial system.

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