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Japanese banks largely avoided the direct impact from the global financial crisis thanks to their limited exposure to foreign toxic assets, the regulatory framework in Japan and the small role of securitisation. However, the sharp contraction in output and plunge in equity prices did have adverse impacts on the banking sector. The authorities responded with measures to stabilise the financial market, inject capital in depository institutions and sustain lending to small companies. These emergency measures should be phased out to limit distortions once a recovery is in place. It is essential to upgrade the regulatory framework by improving the transparency of securitised products, credit rating agencies and capital adequacy regulations. It is also important to address chronic problems, including low profitability, particularly in regional banks, and increase the efficiency of the financial sector. This requires a number of steps, including privatising public financial institutions, enhancing the efficiency of banking services and expanding the range and quality of financial products.