The nation's financial system has stabilized somewhat over the past year or so, but it still has a long way to go before regaining full confidence, as seen in the recent collapse of Sogo Co., Bank of Japan Gov. Masaru Hayami said Friday.

Hayami made the remark during a speech before financial professionals in Tokyo. The speech had been closely watched as it was scheduled only one business day before the central bank's Policy Board discusses whether to lift its 17-month-old "zero-interest-rate" policy Monday.

But Hayami refrained from commenting on the BOJ's monetary policy, citing a self-imposed gag order.

The bank is not speaking to outsiders on its monetary policy during the two working days before the meeting, to avoid what it calls "needless speculation and confusion of market participants."

Speaking on the medium- to long-term challenges facing the banking sector, Hayami said domestic banks have regained international confidence, especially since March 1999, when public funds were infused into them. He cited recent upswings in the credit ratings of banks planning megamergers as another positive sign.

"Of course, even though the (financial system) has restabilized somewhat, there remain many challenges for the system to further stabilize, as seen in the case of Sogo Co.," Hayami said, referring to the department store chain's collapse Wednesday and its negative impact on creditor banks.

Hayami added that domestic banks need to improve their capital structure, urging them to reduce the cost of capital and beef up their internal reserves through accumulation of profits -- rather than continuing on the current heavy reliance on public and other high-cost funds.