Japan should recapitalize its banks next year as well as this year, Deputy U.S. Treasury Secretary Lawrence Summers said Friday.

"Banks may still remain undercapitalized," Summers said in a speech at the Japan National Press Club in Tokyo. "With loss estimates ranging as high as 25 trillion yen, it will be critical to ensure further recapitalization next year."

The Japanese government also has to start selling off its bad assets through bulk sales and securitization to help clean up banks' balance sheets, he said. He welcomed the ongoing financial stabilization process, including the tentative decision by the Financial Reconstruction Commission to inject 7.5 trillion yen in public funds into 15 of the 17 major banks.

He said there still is room for the Bank of Japan to help improve the economy through monetary policy. But he did not address the controversial issue of whether the BOJ should purchase more government bonds on the open market, or recommend any specific steps for the central bank to take.

He suggested the bank should be aware of deflationary risks, noting that the goal of price stability includes avoiding deflation as well as checking inflation. He stressed that Japan must focus on economic growth led by domestic demand, not through increased exports. Fiscal policies — both spending and tax cuts — will be essential until growth has taken root, he added.

"Exchange rates cannot be a substitute for policy," he said, indicating his opposition to a weaker yen as a means to boost Japan's exports.

Summers is visiting Japan on his way from Bonn, Germany, where he attended the finance ministers' meeting of the Group of Seven industrialized nations last week.