25 years after the financial crisis: lessons learned? Interview with former Bank of Japan Deputy Governor Hiroshi Nakaso

We spoke with Hiroshi Nakaso, former vice president of the Bank of Japan and chairman of the Daiwa Institute of Research, who was involved in the response to the financial crisis 25 years ago.

As Director of the Bank of Japan's Credit System Division, Mr. Nakaso was involved in crisis response measures to curb turmoil in the financial system during the financial crisis in which "Yamaichi Securities" and "Long-Term Credit Bank of Japan" failed one after another.

In addition, he has extensive experience in dealing with financial crises both in Japan and overseas, such as dealing directly with central bank executives in various countries during the Lehman shock in 2008.

Q. What kind of discomfort did you feel before the financial crisis?

How do you manifest?

A.Even after the bubble economy burst, the sense of crisis was still weak in the early 1990s, partly because of its residual heat.

Once the aftermath of the bubble is over, the Japanese economy will return to a growth track and asset prices will also begin to rise, so the bank's non-performing loan problem will naturally heal.

I think there was such a vague expectation.

By the spring of 1993, however, there was a growing awareness that the potential size of non-performing loans was actually much larger than expected, and that the problems facing the financial system were quite deep-seated.

From November 1997, when four financial institutions including Yamaichi Securities went bankrupt, to the failure of the Long-Term Credit Bank of Japan and Nippon Credit Bank in 1998, Japan's financial system was pushed to the brink of a meltdown. was a really dangerous situation.

Q. When the crisis hits, it seems that the risks have been underestimated.

A. At the beginning of the 1997 crisis, we did not fully understand the amplification mechanism of the crisis.

Looking back, there are two mechanisms for amplifying crises.

When credit uncertainty increases and the market stops providing funds, it becomes difficult for financial institutions that continue to operate while procuring funds in the market, and financial institutions with weak financial strength deteriorate faster. became.

The second is the negative multiplier effect between finance and the economy.

The turmoil in the financial system has fueled a sense of unease among companies and households, and has dampened capital investment by companies and consumption by households.

A vicious cycle in which the delay in economic recovery prolongs the resolution of the problem of non-performing loans at financial institutions aggravates the financial crisis.

When Japan's financial crisis began, I thought I was aware of these two mechanisms to some extent.

The fear of a financial crisis, I think, is that it aggravates the financial crisis through the activation of dynamic mechanisms that cannot be seen through fixed-point observational analysis alone.

Looking back with regret, I think that the fact that there was at least an underestimation of the risks in the beginning, assuming that it would not be that bad, contributed to the amplification mechanism of the crisis.

Q. Will an interest rate hike in the US lead to another economic and financial crisis?

A. I believe that the progress of global inflation and the tightening of US monetary policy will have various effects on the international financial markets and the world economy.

First, the impact of past financial crises still remains on the international financial markets.

In other words, after the collapse of Lehman Brothers, monetary easing by the U.S. Federal Reserve was continued for an extremely long period of time, making it possible to raise dollar funding at low interest rates.

Excluding the financial sector of emerging countries, the total debt outstanding, which is the sum of borrowings and bond issuances, has nearly tripled since the Lehman Shock.

Under these circumstances, as interest rates turn sharply higher due to the tightening of the FRB, the future increase in dollar funding costs may become a heavy burden for countries and companies with large debt balances.

Furthermore, if the funds that have flown into emerging countries so far flow out to the United States, where interest rates are high, rapidly and on a large scale, the economies of emerging countries could suffer a serious blow.

Therefore, how to avoid chaotic confusion in the flow of international funds?

This becomes a challenge.

Q.What are the challenges to avoid a financial crisis?

The world economy is, of course, greatly influenced by future trends in the US economy, but FRB Chairman Jerome Powell has expressed his determination to persevere until he achieves his mission of controlling inflation.

As a result of the prolonged monetary tightening in the market, there are also those who are worried that the US economy will enter a recession in the future.

It is true that a certain degree of economic slowdown may be unavoidable in order to bring prices down to 2%.

However, the lesson learned from past financial crises is that economic recovery can be achieved relatively quickly as long as the function of financial institutions to support the economy is not lost even in a recession.

Therefore, maintaining the soundness of the financial system will be a major issue in the future.

Q. What is essential and important to survive the crisis?

A. When I look back on Japan's financial crisis, I always remember the people who worked hard at the financial authorities and private institutions during difficult times.

This time 25 years ago, I hardly remember going home.

This is because staying overnight at the workplace during the dark November crisis response has become the norm.

With his colleagues, he would often say to himself, "We're regular customers of Hotel Nichigin."

Hearing this, people from the Banking Bureau of the Ministry of Finance, who were also sleeping in the office at the time, were strangely boasting, "Well, we are Hotel Okura."

It was a tough work environment, but I believe that what united us and supported us was our shared sense of mission to never cause a global financial crisis that originated in Japan.

I think the situation is the same for private financial institutions.

When compared to a sinking ship, it overlapped with the figure of no one trying to leave their post.

And without high work ethic and skill, I think the crisis would have been more ugly.

I think we should never forget that the financial safety net we have today was built on the dedication and sacrifice of many people.

At the same time, it is also important to pass on the DNA of crisis response to the organization.

Individual financial institutions and companies must have learned many lessons in the process of overcoming the financial crisis and the Lehman Shock.

Instead of wiping them away, how can we establish them as the organization's memory and pass them on to the next generation?

I think this is the big issue.

What I think is particularly important is the core of the crisis response mindset, and the organizational culture of persevering when you do your best.

I believe that this must be passed down through the ages.

Q. What should we do to prepare for a crisis that exceeds our expectations?

A. I think that the lessons of the crisis have been learned, and I believe that the know-how that we have accumulated over the course of several crises is fully utilized in today's financial regulations and safety nets.

People often say “lost 10 years” or “20 years,” but I don't think it was 10 or 20 years when everything was lost.

Even so, unexpected things can happen, so I think it is necessary to be prepared for the worst as a key point of crisis management.

For that reason, I think it is necessary to make use of the experience so far, run various simulations, and think about the necessary tools in your head.