| Financial Risk Management | 45 FINANCIAL RISK MANAGEMENT The Group classifies risks into the following categories: credit risk, market risk, liquidity risk and operational risk. This note presents information about the Group’s exposure to credit risk, market risk, and liquidity risk, and its policies and processes for measuring and managing these risks. Risk Management System Based on the recognition of the importance of risk management, the Group-wide basic policies for risk management are determined by the Management Committee before being authorized by the board of directors in order to have top management play an active role in the risk management process. In accordance with these basic policies for risk management, three lines of defense have been defined, and we have clarified related roles and responsibilities. Risk management systems have been established based on the characteristics of particular businesses, and measures are being put in place to strengthen and improve the effectiveness of these systems. Furthermore, the Group is strengthening Group-wide risk management systems through the Group Chief Risk Officer (“CRO”) Committee and the Global CRO Committee. The diagram below represents the risk management system of the Group. Risk Capital Management In managing credit risk, market risk, and operational risk affecting the entire Group, the Group applies a uniform standard, risk capital based on value at risk (“VaR”), for use in monitoring and managing risks. This standard is applied while taking into account the characteristics of each risk and of the businesses of Group companies. Specific risk capital measures include setting upper limits for risk exposure based on Group-wide and business unit risk appetite and Group-wide management constitution. Each business unit operates business operation within that limit. Through these precautions, the Group practices management that maintains an appropriate balance between risks and returns based on a comprehensive perspective and secures sufficient financial soundness. Credit Risk Credit risk is the risk of incurring losses from decline or loss of the value of an asset (including off-balance off-balance Credit risk management system Credit risk is the most significant risk to which the Group is exposed. The purpose of credit risk management is to keep the credit risk exposure to a permissible level relative to capital, to maintain the quality of assets and to ensure returns commensurate with risk. At the Group, the Group CRO formulates credit risk management policies each year on the basis of Group-wide basic policies for risk management. The Credit & Investment Planning Department, responsible for the comprehensive management of credit risk, drafts and administers credit risk regulations including the Group credit policies, manages non-performing The following chart shows the credit risk management system of SMBC, the Group’s significant banking subsidiary. At SMBC, the Credit & Investment Planning Department within the Risk Management Unit is responsible for the comprehensive management of credit risk. This department drafts and administers credit policies, the internal rating system, credit authority guidelines, and credit application guidelines, and manages NPLs, including impaired loans, and other aspects of credit portfolio management. The department also cooperates with the Corporate Risk Management Department in quantifying credit risk (risk capital and risk-weighted assets) and controls SMBC’s entire credit risk. Further, the Credit Portfolio Management Department within the Credit & Investment Planning Department strives to stabilize the credit portfolio and manage the risk through credit derivatives, loan asset sales and other instruments. The credit departments of SMBC within each business unit conduct credit risk management for loans handled by its unit and manage portfolios of its unit. The credit limits they use are based on the baseline amounts that the Credit & Investment Planning Department establishes for each grading category, with particular attention paid to evaluating and managing customers or loans perceived to have particularly high credit risk. The Corporate Research Department engages in research on industries and analyzes the business and financial conditions of borrower enterprises to detect early signs of problems or growth potential. The Credit Administration Department is responsible for handling NPLs of borrowers classified as potentially bankrupt or lower, and formulates plans for workouts, including write-offs, and corporate rehabilitation. The department closely liaises with SMBC Servicer Co., Ltd., a Group company, which engages in related services to efficiently reduce the amount of NPLs, including through the sale of loans. The Internal Audit Unit of SMBC, operating independently of the business units, audits asset quality, accuracy of grading and state of credit risk management, and reports the results directly to the board of directors and the Management Committee. SMBC has established the Credit Risk Committee to undertake control of credit risk and to ensure the overall soundness of the loan operations. Credit risk management methods To effectively manage the risk involved in individual loans as well as the credit portfolio as a whole, the Group first acknowledges that every loan entails credit risk, assesses the credit risk posed by each borrower and loan using an internal rating system, and quantifies that risk for control purposes. Credit risk evaluation At SMBC, the Credit & Investment Planning Department manages an internal rating system for each asset control category set according to portfolio characteristics. For example, credits to commercial and industrial (“C&I”) companies, individuals for business purposes (domestic only), sovereigns, public sector entities, and financial institutions are assigned an “obligor grade,” which indicates the borrower’s creditworthiness, and/or “facility grade,” which indicates the collectability of assets taking into account the transaction conditions such as guarantee/collateral, and tenor. The business units determine an obligor grade by first assigning a financial grade using a financial strength grading model and data obtained from the obligor’s financial statements, including net worth and cash flows. The financial grade is then adjusted taking into account the actual state of the obligor’s financial position and qualitative factors to derive the obligor grade. The qualitative factors mainly include the expected future cash flows taking into account factors such as historical loss information, the appropriateness of the borrower’s business plan or operational improvement plan, the status of progress of its plan, and the overall support from financial institutions. In the event that the borrower is domiciled overseas, internal ratings for credit are made after taking into consideration the country rank, which represents an assessment of the credit quality of each country based on its political and economic situation, as well as its current account balance and external debt. Obligor grades and facility grades are reviewed once a year and as otherwise necessary, such as when there are changes in the credit situation. The Group’s subsidiaries carry out credit risk evaluations in line with SMBC. The table below shows the corporate obligor grading system of SMBC. Obligor Grade Definition Borrower Category Domestic (C&I), etc. Overseas (C&I), etc. J1 G1 Very high certainty of debt repayment Normal J2 G2 High certainty of debt repayment J3 G3 Satisfactory certainty of debt repayment J4 G4 Debt repayment is likely, but this could change in cases of significant changes in economic trends or business environment J5 G5 No problem with debt repayment over the short term, but not satisfactory over the mid to long term, and the situation could change in cases of significant changes in economic trends or business environment J6 G6 Currently no problem with debt repayment, but there are unstable business and financial factors that could lead to debt repayment problems J7 G7 Close monitoring is required due to problems in meeting loan terms and conditions, sluggish/unstable business, or financial problems Borrowers J7R G7R Obligors with loans that are more than three months past due or with restructured loans within the “Borrowers Requiring Caution” category Substandard J8 G8 Currently not bankrupt, but experiencing business difficulties, making insufficient progress in restructuring and highly likely to go bankrupt Potentially J9 G9 Though not yet legally or formally bankrupt, has serious business difficulties and rehabilitation is unlikely; thus, effectively bankrupt Effectively J10 G10 Legally or formally bankrupt Bankrupt There are also grading systems for loans to individuals such as housing loans and structured finance including project finance, where the repayment source is limited to the cash flows generated by a particular business or asset. For example, the obligor grade of housing loans is determined taking into account various relevant factors such as proportion of the repayment to revenue, proportion of down payment to the value and past due information. The Credit & Investment Planning Department of SMBC centrally manages the internal rating systems, and designs, operates, supervises and validates the grading models. It validates the grading models (including statistical validation) of main assets following the procedure manual once a year to ensure their effectiveness and suitability. Quantification of credit risk At SMBC, credit risk quantification refers to the process of estimating the degree of credit risk of a portfolio or individual loan taking into account not just the obligor’s probability of default (“PD”), but also the concentration of risk in a specific customer or industry and the loss impact of fluctuations in the value of collateral, such as real estate and securities. Specifically, the PD by grade, loss given default (“LGD”), credit quality correlation among obligors, and other parameter values are estimated using the historical data of obligors and facilities stored in a database to calculate the credit risk. Then, based on these parameters, SMBC runs a simulation of simultaneous default using the Monte Carlo Simulation to calculate SMBC’s maximum loss exposure to the estimated amount of the maximum losses that may be incurred. Based on these quantitative results, SMBC allocates risk capital. Risk quantification is also executed for purposes such as to determine the portfolio’s risk concentration or to simulate economic movements (stress tests), and the results are used for making optimal decisions across the whole range of business operations, including formulating business plans and providing a standard against which individual credit applications are assessed. Credit assessment At SMBC, the credit assessment of corporate loans involves a variety of financial analyses, including cash flows, to predict an enterprise’s capability of loan repayment and its growth prospects. These quantitative measures, when combined with qualitative analyses of industrial trends, the enterprise’s research and development capabilities, the competitiveness of its products or services, and its management caliber, result in a comprehensive credit assessment. The loan application is analyzed in terms of the intended utilization of the funds and the repayment schedule. In the assessment of housing loans for individuals, SMBC employs a credit assessment model based on credit data amassed and analyzed by SMBC over many years, taking into account various relevant factors including proportion of the repayment to revenue, proportion of down payment to the value and past due information. Credit monitoring At SMBC, in addition to analyzing loans at the application stage, the Credit Monitoring System is utilized to reassess obligor grades, and review credit policies for each obligor so that problems can be detected at an early stage, and quick and effective action can be taken. The system includes annual monitoring that is carried out each time the financial results of the obligor enterprise are obtained, as well as ad-hoc Credit portfolio management Risk-taking within the scope of capital To keep the credit risk exposure to a permissible level relative to capital, the Corporate Risk Management Department of the Company sets a credit risk capital limit for internal control purposes. Under this limit, sub-limits Controlling concentration risk As the Group’s equity capital may be materially impaired in the event that the credit concentration risk becomes apparent, the Credit & Investment Planning Department of the Company therefore takes measures to manage concentration risks, such as introducing large exposure limits and conducting intensive loan reviews for obligors with large exposures, with an increased focus on industrial sectors with an excessive concentration of credit risk. Further, to manage country risk, SMBC’s Credit Department of the International Banking Unit has credit limit guidelines based on each country’s creditworthiness. Toward active portfolio management SMBC’s Credit Portfolio Management Department makes use of credit derivatives, loan asset sales, and other instruments to proactively and flexibly manage its portfolio to stabilize credit risk. Maximum exposure to credit risk before collateral held or other credit enhancements The following table shows the maximum exposure to credit risk before taking into account any collateral held or other credit enhancements at March 31, 2020 and 2019. At March 31, 2020 2019 (In millions) Credit risk exposures relating to assets on the consolidated statements of financial position: Deposits with banks ¥ 61,626,567 ¥ 56,700,489 Call loans and bills bought 898,256 2,465,745 Reverse repurchase agreements and cash collateral on securities borrowed 13,745,996 10,345,994 Trading assets 2,545,703 2,480,903 Derivative financial instruments 6,279,801 3,382,574 Financial assets at fair value through profit or loss 1,454,387 2,620,686 Investment securities: Debt instruments at amortized cost 320,771 318,914 Debt instruments at FVOCI 18,054,164 13,333,221 Loans and advances 94,671,818 90,682,938 Other financial assets 4,229,678 3,609,129 Credit risk exposures relating to off-balance (1) Loan commitments 62,151,698 62,724,820 Financial guarantees and other credit-related contingent liabilities 9,204,996 9,409,066 Total ¥ 275,183,835 ¥ 258,074,479 (1) The off-balance Based on the table above, excluding loan commitments (refer to Note 41 “Contingency and Capital Commitments”), the majority of the total exposure to credit risk is derived from “Loans and advances . Collateral and other credit enhancements The Group considers the acquisition of collateral and guarantees as a secondary repayment source to further enhance loan recovery and minimize credit risk. Based on the assessment of a borrower’s real financial condition and potential future cash flows, the Group shall analyze the borrower’s repayment ability and require sufficient collateral in the form of an asset or third-party obligation. This serves to mitigate the inherent credit risk in the exposure, by either improving recoveries in the event of a default or transferring the borrower’s obligation to guarantors. Collateral received is mainly segregated into (1) financial collateral such as cash, deposits and securities, (2) real estate collateral such as land and buildings, and (3) guarantees received from sovereigns, municipal corporations, credit guarantee corporations and other public entities, financial institutions, and other companies. The Group’s credit risk management is mainly based on an analysis of the repayment ability from the cash flows of the borrower’s business performance, and the collateral and other credit enhancements are considered as secondary repayment sources in the Group’s business practice. At the time of the primary lending decision, the Group evaluates the collateral on an individual borrower basis to consider its financial effect for mitigating credit risk. The re-evaluation The following table shows the financial effect of collateral and other credit enhancements on impaired loans and advances at March 31, 2020 and 2019. The maximum collateral amounts included in the disclosure are limited to the carrying value of loans and advances where the credit exposure is over-collateralized. At March 31, 2020 2019 (In millions) Impaired loans and advances ¥ 845,329 ¥ 882,018 Financial effect of collateral and other credit enhancements 281,382 325,896 Concentration of risks of loans and advances with credit risk exposure An analysis of concentrations of credit risk from loans and advances by geographical sector and industry sector at March 31, 2020 and 2019 is shown below. The concentration by geographical sector is measured based on the domicile of the borrower. Geographical sector At March 31, 2020 2019 (In millions) Domestic ¥ 60,184,755 ¥ 59,856,165 Foreign: Americas 13,866,321 12,382,463 Europe 6,552,895 5,988,133 Asia 11,010,138 9,720,884 Others 4,028,641 3,598,673 Total foreign 35,457,995 31,690,153 Gross loans and advances 95,642,750 91,546,318 Adjust: Unearned income, unamortized premiums—net and deferred loan fees—net (264,527 ) (258,392 ) Less: Allowance for loan losses (706,405 ) (604,988 ) Carrying amount ¥ 94,671,818 ¥ 90,682,938 Industry sector At March 31, 2020 2019 (In millions) Domestic: Manufacturing ¥ 8,787,566 ¥ 8,522,451 Agriculture, forestry, fisheries and mining 280,233 288,099 Construction 919,043 918,617 Transportation, communications and public enterprises 5,637,560 5,596,935 Wholesale and retail 5,375,802 5,281,596 Finance and insurance 3,217,545 3,129,666 Real estate and goods rental and leasing 10,666,446 10,126,531 Services 4,452,195 4,328,173 Municipalities 839,878 866,373 Lease financing 8,380 9,030 Consumer (1) 15,691,638 16,187,195 Others 4,308,469 4,601,499 Total domestic 60,184,755 59,856,165 Foreign: Public sector 335,071 360,875 Financial institutions 6,220,956 5,382,130 Commerce and industry 25,597,599 23,285,374 Lease financing 309,531 344,958 Others 2,994,838 2,316,816 Total foreign 35,457,995 31,690,153 Gross loans and advances 95,642,750 91,546,318 Adjust: Unearned income, unamortized premiums—net and deferred loan (264,527 ) (258,392 ) Less: Allowance for loan losses (706,405 ) (604,988 ) Carrying amount ¥ 94,671,818 ¥ 90,682,938 (1) The balance in Consumer mainly consists of housing loans. The housing loan balances amounted to ¥10,913,869 million and ¥11,216,711 million at March 31, 2020 and 2019, respectively. The following tables show a disaggregation of the structured finance loans and advances balances, where the repayment source is limited to the cash flows generated by a particular business or asset, and the balances of secured or unsecured consumer loans at March 31, 2020 and 2019. These loans and advances are included in the preceding tables. Structured finance: At March 31, 2020 2019 (In millions) Real estate finance ¥ 2,601,130 ¥ 2,493,748 Project finance 4,243,862 3,978,779 Other structured finance 473,436 387,400 Total structured finance ¥ 7,318,428 ¥ 6,859,927 Consumer: At March 31, 2020 2019 (In millions) Secured loans (1) ¥ 11,538,195 ¥ 12,008,728 Unsecured loans 4,153,443 4,178,467 Total consumer ¥ 15,691,638 ¥ 16,187,195 (1) The secured loans and advances mainly represent housing loans. The housing loan balances amounted to ¥10,913,869 million and ¥11,216,711 million at March 31, 2020 and 2019, respectively. Credit quality analysis The following tables set forth information about the gross carrying amount of financial assets and the exposure to credit risk on loan commitments and financial guarantee contracts by stage allocation and internal rating grades of SMBC. Refer to Note 2 “Summary of Significant Accounting Policies” for information on stage allocation. Also refer to Note 45 “Financial Risk Management” for information on obligor grading system of SMBC. At March 31, 2020 12-month Lifetime not credit- Lifetime ECL credit-impaired Total (In millions) Loans and advances at amortized cost: Normal J1-6 ¥ 39,631,009 ¥ 198,143 ¥ — ¥ 39,829,152 G1-6 27,437,173 522,780 — 27,959,953 Japanese government and local municipal corporations 3,091,323 — — 3,091,323 Other (1) 22,837,826 111,801 — 22,949,627 Requiring caution J7 — 579,539 — 579,539 G7 — 202,207 — 202,207 Other (1) — 185,620 — 185,620 Impaired (2) — — 845,329 845,329 Gross loans and advances 92,997,331 1,800,090 845,329 95,642,750 Adjust: Unearned income, unamortized premiums—net and deferred loan fees—net (264,527 ) Less: Allowance for loan losses (203,286 ) (147,382 ) (355,737 ) (706,405 ) Carrying amount ¥ 94,671,818 (1) The balance of “Other” includes housing loans, which amounted to ¥10,799,400 million and ¥21,898 million for the borrower category of Normal and Requiring Caution, respectively. (2) “Impaired” refers to loans and advances to borrowers with obligor grades not higher than 7R. At March 31, 2019 12-month Lifetime ECL not credit- Lifetime ECL credit-impaired Total (In millions) Loans and advances at amortized cost: Normal J1-6 ¥ 38,708,431 ¥ 191,177 ¥ — ¥ 38,899,608 G1-6 24,350,586 508,277 — 24,858,863 Japanese government and local municipal corporations 3,137,657 — — 3,137,657 Other (1) 22,876,865 75,598 — 22,952,463 Requiring caution J7 — 460,319 — 460,319 G7 — 171,441 — 171,441 Other (1) — 183,949 — 183,949 Impaired (2) — — 882,018 882,018 Gross loans and advances 89,073,539 1,590,761 882,018 91,546,318 Adjust: Unearned income, unamortized premiums—net and deferred loan fees—net (258,392 ) Less: Allowance for loan losses (158,094 ) (92,446 ) (354,448 ) (604,988 ) Carrying amount ¥ 90,682,938 (1) The balance of “Other” includes housing loans, which amounted to ¥11,084,927 million and ¥28,018 million for the borrower category of Normal and Requiring Caution, respectively. (2) “Impaired” refers to loans and advances Modified loans and advances that were subject to lifetime ECL measurement amounted to ¥42,420 million and ¥28,908 million for the fiscal years ended March 31, 2020 and 2019, respectively. The net modification gain or loss is not material. At March 31, 2020 12-month Lifetime Lifetime Total (In millions) Loan commitments and Financial Guarantees (1) Gross carrying amount ¥ 29,711,738 ¥ 276,070 ¥ 24,820 ¥ 30,012,628 Allowance for off-balance 46,118 21,423 3,713 71,254 At March 31, 2019 12-month Lifetime Lifetime Total (In millions) Loan commitments and Financial Guarantees (1) Gross carrying amount ¥ 28,842,267 ¥ 383,828 ¥ 13,435 ¥ 29,239,530 Allowance for off-balance 36,795 18,289 5,761 60,845 (1) Loan commitments are the undrawn components of loan commitments on which ECL can be separately identified from those on the drawn components. Movements in ECL allowance The following tables show reconciliations from the opening balance to the closing balance of the ECL allowance by class of financial instrument. 12-month Lifetime ECL Lifetime ECL credit-impaired Total (In millions) Loans and advances at amortized cost (1) Balance at April 1, 2018 ¥ 164,515 ¥ 130,701 ¥ 356,404 ¥ 651,620 Transfer to 12-month 832 (805 ) (27 ) — Transfer to lifetime ECL not credit-impaired (1,599 ) 4,845 (3,246 ) — Transfer to lifetime ECL credit-impaired (1,966 ) (10,507 ) 12,473 — Net transfers between stages (2,733 ) (6,467 ) 9,200 — Provision (credit) for loan losses (2) (4,265 ) (31,744 ) 158,936 122,927 Charge-offs (3) — — 180,254 180,254 Recoveries — — 11,042 11,042 Net charge-offs — — 169,212 169,212 Others 577 (44 ) (880 ) (347 ) Balance at March 31, 2019 ¥ 158,094 ¥ 92,446 ¥ 354,448 ¥ 604,988 Transfer to 12-month 880 (829 ) (51 ) — Transfer to lifetime ECL not credit-impaired (2,414 ) 4,264 (1,850 ) — Transfer to lifetime ECL credit-impaired (1,650 ) (7,938 ) 9,588 — Net transfers between stages (3,184 ) (4,503 ) 7,687 — Provision for loan losses (4) 52,085 60,724 136,669 249,478 Charge-offs (3) — — 153,992 153,992 Recoveries — — 12,413 12,413 Net charge-offs — — 141,579 141,579 Others (3,709 ) (1,285 ) (1,488 ) (6,482 ) Balance at March 31, 2020 ¥ 203,286 ¥ 147,382 ¥ 355,737 ¥ 706,405 (1) “Loans and advances at amortized cost” includes allowance for undrawn components of loan commitments issued to retail customers which cannot be separately identified from that for the drawn components. (2) The decrease of allowance of lifetime ECL not credit-impaired is primarily due to certain large borrowers’ improvement of their financial performance. (3) Charge-offs for lifetime ECL credit-impaired are primarily related to those for consumer loans. (4) The increase of allowance for 12-month ECL and lifetime ECL not credit-impaired for the fiscal year ended March 31, 2020 is primarily due to the incorporation of forward-looking macroeconomic information reflecting the impact of the COVID-19 economic outlook. For the fiscal year ended March 31, 2020, the ECL reflected the current and forward-looking impact of the COVID-19 pandemic. The negative impact on the Japanese and global economy was assumed to remain throughout the fiscal year ending March 31, 2021 and the allowance for 12-month ECL and lifetime ECL not credit-impaired for the fiscal year ended March 31, 2020 increased. Furthermore, an additional ECL adjustment was made for portfolios whose credit risk was significantly affected by the decline in oil prices. For additional information, refer to Note 3 “Critical Accounting Estimates and Judgments.” 12-month Lifetime ECL Lifetime ECL credit-impaired Total (In millions) Loan commitments and financial guarantees (1) Balance at April 1, 2018 ¥ 35,543 ¥ 23,311 ¥ 6,225 ¥ 65,079 Net transfers between stages (28 ) (228 ) 256 — Provision (credit) for off-balance 2,272 (4,794 ) (720 ) (3,242 ) Others (992 ) — — (992 ) Balance at March 31, 2019 ¥ 36,795 ¥ 18,289 ¥ 5,761 ¥ 60,845 Net transfers between stages (87 ) (173 ) 260 — Provision (credit) for off-balance 9,461 3,307 (2,308 ) 10,460 Others (51 ) — — (51 ) Balance at March 31, 2020 ¥ 46,118 ¥ 21,423 ¥ 3,713 ¥ 71,254 (1) ECL allowance for loan commitments is that for the undrawn components of loan commitments, which can be separately identified from that for the drawn components. Trading assets, financial assets at fair value through profit or loss and investment securities The following tables show an analysis of trading assets, financial assets at fair value through profit or loss and debt instruments at amortized cost and at fair value through other comprehensive income based on the external rating system at March 31, 2020 and 2019, excluding instruments with equity features. Collateral is generally not obtained directly from the issuers. At March 31, 2020 Trading assets (1) Financial assets at (1) Debt instruments at (1)(2) Debt instruments at (1)(2) (In millions) AAA ¥ 101,336 ¥ 10,005 ¥ — ¥ 8,104,653 AA- 2,125,095 346,039 282,379 8,236,637 A- 135,445 23,981 — 763,612 Lower than A- 98,275 106,682 38,299 694,051 Unrated 7,193 559 93 26,627 Total ¥ 2,467,344 ¥ 487,266 ¥ 320,771 ¥ 17,825,580 At March 31, 2019 Trading assets (1) Financial assets at (1) Debt instruments at (1)(2) Debt instruments at (1)(2) (In millions) AAA ¥ 242,984 ¥ 12,537 ¥ — ¥ 6,520,641 AA- 1,907,495 1,254,294 280,246 5,930,057 A- 182,306 29,233 203 235,065 Lower than A- 80,851 165,108 38,387 642,091 Unrated 4,652 568 78 15,313 Total ¥ 2,418,288 ¥ 1,461,740 ¥ 318,914 ¥ 13,343,167 (1) The amounts represent fair value for trading assets and financial assets at fair value through profit or loss, whereas they represent the gross carrying amount for debt instruments at amortized cost and at fair value through other comprehensive income. (2) There were no debt instruments at amortized cost or debt instruments at fair value through other comprehensive income subject to lifetime ECL at March 31, 2020 and 2019. Credit risk from derivative financial instruments The Group maintains control limits on derivative positions, by both amount and term. At any one time, the amount subject to credit risk is limited to the fair value of derivative financial instruments that are favorable to the Group (i.e., assets where their fair value is positive). The Group’s credit risk from derivatives is mitigated where possible through netting agreements whereby derivative assets and liabilities with the same counterparty can be offset. Netting agreements, such as the ISDA master agreement, allow the netting of obligations arising under all of the derivative transactions that the agreement covers upon the counterparty’s default, regardless of maturity and currency, resulting in a single net claim against the counterparty. The Group’s credit risk is also mitigated by collateral arrangements through the credit support annex, resulting in collateral delivered or received regularly based on the replacement costs of derivatives. Market Risk and Liquidity Risk Market risk is the possibility that fluctuations in interest rates, foreign exchange rates, stock prices or other market prices will change the market value of financial products, leading to a loss. The purpose of market risk management is to keep the market risk exposure to a permissible level relative to capital. Liquidity risk is defined as the uncertainty around the ability to meet debt obligations without incurring unacceptably large losses. An example of such risk is the possible inability to meet current and future cash flow/ collateral needs, both expected and unexpected. In such cases, the Group may be required to raise funds at less than favorable rates or be unable to raise sufficient funds for settlement. The purpose of liquidity risk management is to ensure that the Group is in a position to address its liquidity obligations through monitoring the liquidity gap between assets and liabilities, and by maintaining highly liquid supplementary funding resources. On the basis of the Group-wide basic policies for risk management, the Group has a quantitative management process to control market and liquidity risks on a Group-wide basis by setting allowable risk limits by company. The Group at least annually reviews and identifies which companies primarily carry the market and liquidity risks within the Group. The Group sets permissible levels and upper limits of risk for each identified company in consideration of those companies’ business plans. The Group ensures that each identified company establishes a risk management system that is appropriate to the risks it faces, and has built-in Framework for market and liquidity risk management The board of directors authorizes important matters relating to the management of market and liquidity risks, such as the basic policies and risk limits, which are decided by the Management Committee. The Corporate Risk Management Department, which is independent of the business units that directly handle market transactions, manages market and liquidity risks in an integrated manner. The Corporate Risk Management Department not only monitors the current risk situations but also reports regularly to the Management Committee and the board of directors. Additionally, the Asset Liability Management (“ALM”) Committee meets on a quarterly basis to examine reports on the state of market and liquidity risk management and to discuss the Group’s ALM operation policies. Furthermore, SMBC’s ALM Committee meets on a monthly basis to examine reports on the state of observance of SMBC’s limits on market and liquidity risks, and to discuss SMBC’s ALM operations. Under the Group’s internal audit system, internal audits are also periodically performed to verify that the risk management framework is functioning properly. The following chart shows the market and liquidity risk management system of SMBC. Market risk management methods The Group manages market risk derived from trading activities and non-trading The Group’s market risk can be divided into various factors: interest rates, foreign exchange rates, equity prices and option risks. The Group manages each of these risks by employing the VaR method as well as supplemental indicators suitable for managing each risk, such as the basis point value (“BPV”). VaR is the largest predicted loss that is possible given a fixed confidence interval. For example, the Group’s VaR indicates the largest loss that is possible for a holding period of one day and a confidence interval of 99.0%. BPV is the amount of change in assessed value as a result of a one-basis-point Value at risk The principal Group companies’ internal VaR model makes use of historical data to prepare scenarios for market fluctuations and |
