TOKYO (AFX-ASIA) - Bank of Japan governor Masaru Hayami said the central bank will closely monitor foreign exchange movements, concentrating on the dollar/yen, and the global flow of funds due to uncertainty over the US economic recovery. The dollar/yen has been moving towards a stronger yen since the spring this year, "a turnaround from the weaker yen seen at the end of last year," Hayami told a meeting of business people. "This reflects the market's bearish view of the future of the US economic recovery and its effect on expectations for the Japanese economy," he said. "We want to closely watch forex market movements, as well as the international flow of funds, in light of this," he added. Meanwhile, Hayami said the outstanding balance of bad loans at Japanese banks is not declining so remarkably, though progress has been made in disposing of non-performing debt to large firms, led by the Financial Services Agency. "There will be an increasing number of companies who are required to reorganise their management drastically, given structural reforms. Deterioration is expected in the banks' exposure to corporations in the short-run," he said. "Our challenge will now be how to deal with loans to mid-sized and smaller companies because banks have made progress in the disposal of bad loans to large firms through the FSA's special inspections," he said. The FSA instigated a series of investigations in the condition of banks' loans, as well as their borrowers, which has encouraged financial institutions to increase disposals of debt of dubious or uncertain value. "Given the severe economic conditions deterioration in loans will continue," Hayami said. "Banks need to improve profitability in their core business to deal with weakening financial health, on the back of a fall in stock prices." Declines in Japanese equity market valuations hit banks' capital levels due to the large level of stock holdings on their balance sheets. Hayami said the government may need to offer additional public funds to recapitalise the banks in the face of a financial crisis. "We need to secure financial stability. If necessary, the government should take proper action, including the injection of public funds into banks. The BoJ will act as a lender of last resort if necessary," he said. "Although the number of banks has been declining... banks should not baulk at further mergers," he added.