No.6   June 1, 2000   Establishing New Financial Markets in Japan   Masatoshi KURATANI & Yukihiko ENDO        In recent years, Japan's big bang has made steady progress in the financial markets. At the same time, however, a crisis occurred in the country's financial system, which received an injection of taxpayer money. These developments have had various ripple effects on the markets--effects that have not always acted in the same direction.    Resorting to taxpayer money in order to widen the safety net under the financial system risks creating moral hazard among depositors, banks and regulators via a variety of mechanisms. After some ups and downs, the United States has come to attach great importance to the restraint of moral hazard and has taken a number of measures, including resort to Prompt Corrective Action.    Japan also needs to devise banking regulations that are compatible with its aim of deregulating its financial services industry and take account of the fact that the banking industry has been the recipient of taxpayer money. The approach that should be adopted is to devise rules that encourage market discipline and create incentives for banks to be more efficient while trying to stabilize the financial system with the smallest safety net possible.    However, with the economy growing more slowly and the price of land falling, there is a risk that merely trying to stabilize the banking sector may lead to soaring costs. A more fundamental approach would be to develop more alternative financing channels and improve their efficiency. Measures along these lines, such as a clearer statement of fiduciary duty, strengthening the functions of venture capital to screen and monitor startup businesses, and the greater use of securitization, are likely to prove most effective.    Also likely to prove effective--by increasing the professional expertise of those working in the country's financial markets and developing alternative channels of service--are efforts to minimize the risk of moral hazard, extend financial deregulation and improve the quality of the various economic institutions that serve as infrastructure, as well as more advanced city functions. Contents I Japan's Capital Markets in the 1990s II The Functions and Risks of Financial Markets 1 Economic Growth and Financial Markets 2 Various Market Risks III Safety Nets and Moral Hazard 1 Portfolio Selection and Moral Hazard 2 The Banking System and Moral Hazard 3 US Experience 4 The FDIC Improvement Act 5 Issues for Japan IV Developing a Range of Channels for Financial Services 1 Developing More Channels 2 Relationship with the Banking Channel V Specialization in Financial Services and Cities 1 Cities and the Accumulation of Professional Expertise 2 Conditions Necessary for Developing More Sophisticated Financial Services GO to PDF