The headquarters of the Bank of Japan, the country's central bank, in Tokyo. [KIYOSHI OTA / BLOOMBERG]

HONG KONG - Chinese and Japanese efforts to bypass the dollar by directly exchanging yen and yuan will improve financial stability in Asia, Kiyohiko Nishimura, a deputy governor of Japan's central bank, said on Wednesday.

Financial institutions can reduce settlement risks if the dollar is not needed as an intermediary currency, Nishimura said in a speech posted on the Bank of Japan's website.

"As such, the development of financial and foreign-exchange markets denominated in yen and yuan is an important issue for financial stability, not only for Japan and China but also for the rest of Asia," Nishimura said.

The world's second- and third-largest economies announced plans to promote direct yen-yuan trading in December after a meeting between Premier Wen Jiabao and Japanese Prime Minister Yoshihiko Noda in Beijing.

A direct and liquid market for exchanging the currencies will also reduce transaction costs, Nishimura said.

The Chinese currency on Wednesday approached an 18-year high against the dollar ahead of a visit by Vice-President Xi Jinping to the United States and as Greece negotiated a rescue.

The yuan rose 0.16 percent to 6.2947 by 1:14 pm local time.

Efforts by China to give its currency a broader global role and reduce dependence on the dollar are being limited by the nation's capital controls.

"It would be implausible to assume that yuan internationalization will be further developed without significant capital-flow deregulation," Nishimura said.

"Strict" regulations on inflows to China "have gradually become an obstacle to the further development of offshore yuan markets", he said.

In his speech, the official also highlighted the potential for Japanese government bonds to be a benchmark for Asian markets, playing the same role as German debt in Europe.

Bloomberg News