PINX:SMFNF Sumitomo Mitsui Financial Group Inc Annual Report 20-F Filing - 3/31/2012
Effective Date 3/31/2012
| • ANNUAL REPORT • SHARE HANDLING REGULATIONS • LIST OF SUBSIDIARIES • CEO CERTIFICATION REQUIRED BY 17 CFR 240.13A-14(A • CFO CERTIFICATION REQUIRED BY 17 CFR 240.13A-14(A • CERTIFICATION REQUIRED BY 17 CFR 240.13A-14(B) AND 18 U.S.C. 1350 • CERTIFICATION REQUIRED BY 17 CFR 240.13A-14(B) AND 18 U.S.C. 1350 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 20-F
(Mark One)
OR
OR
OR
Commission file number: 001-34919 Kabushiki Kaisha Mitsui Sumitomo Financial Group (Exact name of registrant as specified in its charter) SUMITOMO MITSUI FINANCIAL GROUP, INC. (Translation of registrant’s name into English)
Haruyuki Nagata 1-2, Marunouchi 1-chome, Chiyoda-ku, Tokyo 100-0005, Japan Telephone: +81-3-3282-8111 Facsimile: +81-3-4333-9954 (Name, telephone, e-mail and/or facsimile number and address of company contact person) Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act: None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report. At March 31, 2012, the following shares of capital stock were outstanding: 1,414,055,625 shares of common stock (including 62,939,559 shares of common stock held by the registrant and its consolidated subsidiaries and equity-method associates as treasury stock).
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨ If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. Item 17 ¨ Item 18 ¨ If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
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Table of ContentsCERTAIN DEFINED TERMS, CONVENTIONS AND PRESENTATION OF FINANCIAL INFORMATION As used in this annual report, unless the context otherwise requires, “SMFG,” the “Company,” “we,” “us,” “our” and similar terms refer to Sumitomo Mitsui Financial Group, Inc. as well as to its subsidiaries, as the context requires. References to the “Group” are to us and our subsidiaries and affiliates taken as a whole. “SMBC” and the “Bank” refer to Sumitomo Mitsui Banking Corporation or to Sumitomo Mitsui Banking Corporation and its consolidated subsidiaries taken as a whole, depending on the context. The Bank is our main subsidiary. In this annual report, all of our financial information is presented on a consolidated basis, unless we state otherwise. As used in this annual report, “IFRS” means International Financial Reporting Standards as issued by the International Accounting Standards Boards, the “IASB,” and “Japanese GAAP” means accounting principles generally accepted in Japan. Our consolidated financial information in this annual report has been prepared in accordance with IFRS, except for the risk-weighted capital ratios, the segment results of operation and some other specifically identified information, which are prepared in accordance with Japanese banking regulations or Japanese GAAP. Unless otherwise stated or the context otherwise requires, all financial information contained in this annual report is expressed in Japanese yen. Our fiscal year ends on March 31. Unless otherwise specified or required by the context: references to “days” are to calendar days; references to “years” are to calendar years and to “fiscal years” are to our fiscal years ending on March 31; references to “$,” “dollars” and “U.S. dollars” are to United States dollars; references to “euros” and “€” are to the currency of those member states of the European Union which are participating in the European Economic and Monetary Union pursuant to the Treaty on European Union; references to “£” and “British pounds sterling” are to the currency of the United Kingdom; and references to “yen” and “¥” are to Japanese yen. Unless otherwise specified, when converting currencies into yen, we use the median exchange rates for buying and selling spot dollars, or other currencies, by telegraphic transfer against yen as determined by the Bank on March 31, 2012. Unless otherwise indicated, in this annual report, where information is presented in millions, billions or trillions of yen or thousands, millions or billions of dollars, amounts of less than one thousand, one million, one billion or one trillion, as the case may be, have been rounded. Accordingly, the total of figures presented in columns or otherwise may not equal the total of the individual items. All percentages have been rounded to the nearest percent, one-tenth of one percent or one-hundredth of one percent, as the case may be, except for capital ratios, which have been truncated. We implemented a 100-for-1 stock split of shares of our common stock and adopted a unit share system effective on January 4, 2009, pursuant to which one hundred shares constitutes one unit of shares. The 100-for-1 stock split and the adoption of the unit share system do not apply to shares of our preferred stock. Numbers of shares of our common stock and per share information for our common stock, for example historical dividend information, in this annual report have been retroactively adjusted to reflect the 100-for-1 stock split effective on January 4, 2009.
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Table of ContentsCAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This annual report contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the U.S. Securities Exchange Act of 1934, as amended. When included in this annual report, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “probability,” “risk,” “project,” “should,” “seek,” “target,” “will” and similar expressions, among others, identify forward-looking statements. You can also identify forward-looking statements in the discussions of strategy, plans or intentions. Such statements, which include, but are not limited to, statements contained in “Item 3. Key Information—Risk Factors,” “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk,” reflect our current views with respect to future events and are inherently subject to risks, uncertainties and assumptions, including the risk factors described in this annual report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described here as anticipated, believed, estimated, expected or intended. The U.S. Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking information to encourage companies to provide prospective information about themselves. We rely on this safe harbor in making these forward-looking statements. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ from those in the forward-looking statements as a result of various factors, and the differences may be material. Potential risks and uncertainties include, without limitation, the following:
Given these and other risks and uncertainties, you should not place undue reliance on forward-looking statements, which speak only as of the date of the filing of this annual report. We expressly disclaim any obligation to update or to announce publicly any revision to any of the forward-looking statements contained in this annual report to reflect any changes in events, conditions, circumstances or other developments upon which any such statement is based. The information contained in this annual report identifies important factors in addition to those referred to above that could cause differences in our actual results.
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Not applicable.
Not applicable.
Selected Financial Data The following selected financial data at and for each of the four fiscal years ended March 31, 2012, 2011, 2010 and 2009 have been derived from our consolidated financial statements. You should read this data together with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements included elsewhere in this annual report.
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Table of ContentsExchange Rates We maintain our accounts in yen. The following table sets forth for the indicated periods the median exchange rates for buying and selling spot dollars by telegraphic transfer against yen as determined by the Bank, expressed in Japanese yen per $1.00.
The median exchange rate quotation by the Bank for buying and selling spot dollars by telegraphic transfer against yen on July 10, 2012 was ¥79.53 = $1.00. These exchange rates are reference rates and are neither necessarily the rates used to calculate ratios nor the rates used to convert dollars to yen in the consolidated financial statements included elsewhere in this annual report. 3.B. CAPITALIZATION AND INDEBTEDNESS Not applicable. 3.C. REASONS FOR THE OFFER AND USE OF PROCEEDS Not applicable. Investing in our securities involves risks. You should carefully consider the risks described below as well as all the other information in this annual report, including, but not limited to, our consolidated financial statements and related notes included elsewhere in this annual report and “Item 11. Quantitative and Qualitative Disclosures about Credit, Market and Other Risk.” Our business, operating results and financial condition could be adversely affected by any factors, including, but not limited to, those discussed below. The trading prices of our securities could also decline due to any of these factors including, but not limited to, those discussed below. Moreover, this annual report contains forward-looking statements that involve risks and uncertainties. Our actual results could also differ from those anticipated in these forward-looking statements as a result of various factors, including, but not limited to, the risks faced by us described below and elsewhere in this annual report. See “Cautionary Statement Regarding Forward-Looking Statements.” Forward-looking statements in this section are made only as of the filing date of this annual report.
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Table of ContentsRisks Related to the Economic and Financial Environment We may be adversely affected if Japanese and global economic conditions and financial markets deteriorate. Our financial condition and results of operations are materially affected by general economic conditions and financial markets in Japan and foreign countries. In the aftermath of the Great East Japan Earthquake, a magnitude 9.0 earthquake which occurred in March 2011, and collateral events, the Japanese economy contracted due to a combination of supply chain disruptions, electricity shortages and the consequential slowdown in exports. It gradually recovered as supply chains and lost output from the earthquake and collateral events were restored. In the second half of the fiscal year ended March 31, 2012 there were some visible signs of improvement in the unemployment rate, and private consumption remained firm. The rate of recovery of the Japanese economy slowed due to the persistent strength of the Japanese yen against other currencies and a weak recovery of the global economies. In the second half of the fiscal year ended March 31, 2012, the U.S. economy began to recover. However, financial market anxiety owing to the European sovereign debt crisis continued and some European nations experienced recessionary conditions. The growth rate of China, India and other emerging economies in Asia began declining. Geopolitical instability in various parts of the world, including North Africa, the Middle East and Asia, could contribute to economic instability in those and other regions. Future deterioration of general economic conditions in Japan or other countries, or financial market turmoil, could adversely affect our business, financial condition and operating results. Such adverse effects could include a worsening of our liquidity and capital conditions, an increase in our credit costs, and an increase in impairment of our investment securities. Risks Related to Our Business Failure to satisfy capital adequacy requirements could constrain our and the Bank’s operations. We and the Bank are subject to capital adequacy requirements set by the Financial Services Agency of Japan (“FSA”). At March 31, 2012, our risk-weighted consolidated capital ratio was 16.93% compared to the minimum required risk-weighted capital ratio of 8.0%, and our Tier I risk-weighted capital ratio was 12.28% compared to the minimum required Tier I risk-weighted capital ratio of 4.0%. Our and the Bank’s capital ratios could decline as a result of decreases in Tier I and Tier II capital or increases in risk-weighted assets. The following circumstances, among others, could reduce our risk-weighted capital ratio and that of the Bank:
Furthermore, our Tier II capital cannot exceed our Tier I capital. If our Tier I capital is reduced, then amounts that may be credited as Tier II capital may be reduced as well because at least half of our capital must consist of Tier I capital. Failure by us or the Bank to maintain the minimum risk-weighted capital ratios may result in administrative actions or sanctions, which may indirectly affect our or the Bank’s ability to fulfill our and the Bank’s contractual obligations or may result in restrictions on our and the Bank’s businesses. We and the Bank have adopted the advanced internal rating-based (“IRB”) approach for measuring exposure to credit risk and the advanced measurement approach (“AMA”) to measure exposure to operational risk. If the FSA revokes its approval of such implementation or otherwise changes its approach to measure capital adequacy ratios, our and the Bank’s ability to maintain capital at the required levels may be adversely affected.
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Table of ContentsFSA regulations limit the amount of deferred tax assets which may be included in our and the Bank’s regulatory capital. The amount of net deferred tax assets established pursuant to Japanese GAAP that major banks may include in regulatory capital for capital ratio purposes is limited to 20% of Tier I capital. Where net deferred tax assets of a bank exceed this 20% limit, Tier I capital must be adjusted by deducting the amount in excess of the limit. If the percentages of our capital that consist of net deferred tax assets increase, or if the limits are further decreased, these limits could adversely affect our capital ratios. Furthermore, under the new Basel III rules text published by the Basel Committee on Banking Supervision (“Basel Committee”) in December 2010, deferred tax assets that arise from timing differences will be recognized as part of the common equity component of Tier I, with recognition capped at 10% of the bank’s common equity component under certain conditions, while deferred tax assets that arise from net loss carry forwards will be deducted from the common equity component of Tier I. The FSA changed its capital adequacy guidelines to generally reflect the main measures of the minimum capital requirements of the Basel Committee that are scheduled to be phased in starting January 1, 2013, and the FSA’s changes will be generally applied from March 31, 2013. On November 4, 2011, we and other organizations were identified by the Financial Stability Board (“FSB”) as Global Systemically Important Financial Institutions (“G-SIFIs”). The list of G-SIFIs will be updated each year in November and from 2016, requirements for additional loss absorption capacity above the Basel III minimum requirement will apply to those banks identified in November 2014 as G-SIFIs. If our capital ratios fall below required levels, the FSA may require us to take a variety of corrective actions, including withdrawal from all international operations or suspension of all or part of our and the Bank’s operations. In addition, some of the Bank’s domestic and overseas subsidiaries are also subject to local capital ratio requirements. Failure of those subsidiaries to meet local requirements may result in administrative actions or sanctions imposed by local regulatory authorities. Future declines of securities prices on Japanese stock markets or other global markets could cause us to experience impairment losses and unrealized losses on our equity securities portfolio, which could negatively affect our financial condition, operating results and regulatory capital position. The reported value of our available-for-sale equity instruments accounted for 2.2% of our total assets at March 31, 2012, approximately 89.0% of which were Japanese equity securities. This value depends mainly on prices of the instruments in the stock market. A listed equity security is impaired primarily based on its market price. If we conclude that a particular security is impaired, we calculate the impairment loss based on the market price of that security at the end of the relevant period. Declines in the Japanese stock markets or other global markets could result in further losses from impairment of the securities in our equity securities portfolio or sales of these securities, adversely affecting our results of operations and financial condition. Our regulatory capital position and that of the Bank depend in part on the fair value of our equity securities portfolio, since 45% of unrealized gains are counted as Tier II capital, while unrealized losses reduce net assets and Tier I capital. Substantial declines in the Japanese stock markets or other global markets would negatively affect our and the Bank’s capital positions, and limit the Bank’s ability to make distributions to us. We may further reduce our holdings of equity securities in order to reduce financial risks. Any disposal by us of equity holdings in our customers’ shares could adversely affect our relationships with those customers. Changes in the levels or volatility of market rates or prices could adversely affect our financial condition and results of operations. We engage in trading and investing activities dealing with various kinds of financial instruments such as bonds, equities, currencies, derivatives and funds. Our financial condition and results of operations could be adversely affected by actual changes or volatility in interest rates, foreign exchange rates and market prices of other investment securities. For example, we have substantial investments in debt securities. In particular,
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Table of ContentsJapanese government bonds represent a significant part of our fixed income portfolio. At March 31, 2012, we had ¥23 trillion of Japanese government bonds classified as available-for-sale financial assets, which accounted for approximately 15.9% of our total assets. Increases in interest rates could substantially decrease the value of our fixed income portfolio, and any unexpected changes in yield curves could adversely affect the value of our bond and interest rate derivative positions, resulting in lower-than-expected revenues from trading and investment activities. Market volatility may also result in significant unrealized losses or impairment losses on such instruments. Furthermore, the downgrading of investment securities by credit rating agencies may also cause declines in the value of our securities portfolio. Adverse economic conditions and deterioration of the financial conditions of our customers could increase our credit costs. We have substantial exposure to corporate customers in the following sectors: manufacturing, real estate and goods rental and leasing, wholesale and retail, transportation, communications and public enterprises, and services, including electric utilities, and to individual customers mainly through housing loans. Our non-performing loans (“NPLs”) and our credit costs for corporate and individual customers may increase significantly if:
Moreover, in relation to the Great East Japan Earthquake, we may be required to, or choose to, provide new or additional financing to customers who may incur unexpected liabilities, have difficulty in the future in continuing operations, encounter difficulties or need to devote significant resources to repair their infrastructures, as a result of the earthquake and collateral events. We may also be required to record increases in our allowance for loan losses as a result of the adverse impact on the financial condition of our obligors or recognize decreases in the value of mortgaged property in the affected regions and our equity securities portfolio. For certain borrowers, we may choose to engage in debt-for-equity swaps, or provide partial debt write-offs, additional financing or other forms of assistance as an alternative to exercising our full legal rights as a creditor if we believe that doing so may increase our ultimate recoverable amount of the loan. Moreover, changes in laws or government policies that have an adverse impact on the rights of creditors could also cause us to incur increased credit costs. It is unclear to what extent our current or any future loans to borrowers will benefit, directly or indirectly, from any government guarantees or other government support measures that have been or may be enacted as a result of the earthquake and collateral events. In addition, our NPLs may increase and there may be additional credit costs if we fail to accurately estimate the incurred losses in our loan portfolio. These estimates require difficult, subjective and complex judgments such as credit evaluation of our borrowers, valuation of collateral and forecasts of economic conditions. The ratio of impaired loans and advances to the total loans and advances, both net of allowance for loan losses, were 1.9%, 1.8% and 1.6% at March 31, 2012, 2011 and 2010, respectively. For further information, see “Item 5.A. Operating Results—Loans and Advances.” A significant downgrade of our credit ratings could have a negative effect on us. At the date of this annual report, SMFG has the issuer credit ratings of A/A-1 from Standard & Poor’s Ratings Japan K.K., (“S&P”), and the long-term foreign and local currency issuer default ratings (“IDRs”) of A- and the short-term foreign and local currency IDRs of F1 from Fitch Ratings Japan Limited (“Fitch”). There can be no assurance that these ratings will be maintained.
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Table of ContentsOn August 24, 2011, Moody’s Japan K.K., (“Moody’s”) announced that it had downgraded by one notch the Government of Japan’s local and foreign currency bond ratings to Aa3. On the same date, Moody’s also downgraded by one notch the long term debt ratings of many Japanese banks, including the Bank’s long-term debt ratings, due to fiscal pressures on the Government of Japan that might constrain its ability to support Japan’s banking system. On November 29, 2011, S&P, in connection with the application of its new ratings criteria for banks, revised downward the rating or outlook of financial institutions globally, including a revision of SMFG’s and the Bank’s outlook from stable to negative. On May 22, 2012, Fitch announced that it had downgraded the Government of Japan’s long-term local and foreign currency IDRs to A+ with negative outlook. On July 20, 2012, Fitch downgraded by one notch the long-term foreign and local currency IDRs of the major Japanese banking groups and their subsidiaries, including SMFG and the Bank, in connection with the sovereign downgrade. A material downgrade of our credit ratings may have various effects including, but not limited to, the following:
Any of these or other effects of a downgrade of our credit ratings could have a negative impact on the profitability of our treasury and other operations, and could adversely affect our regulatory capital position, financial condition and results of operations. For more information about our credit ratings, see “Item 5.B. Liquidity and Capital Resources.” We face significant challenges in achieving the goals of our business strategy, and our business may not be successful. In May 2011, we and the Bank launched a new medium-term management plan through March 2014. We believe that we have targeted appropriate business areas. However, our initiatives to offer new products and services and to increase sales of our existing products and services may not succeed, if current market conditions do not stabilize, market opportunities develop more slowly than expected, our initiatives have less potential than we envisioned originally or the profitability of these products and services is undermined by competitive pressures. Consequently, we may be unable to achieve or maintain profitability in our targeted business areas. In order to implement our business strategy successfully, we need to hire and train qualified personnel continuously and in a proactive manner, as well as to attract and retain employees with professional experience and specialized product knowledge. However, we face competition from other commercial banks, investment banks, consumer finance companies and other financial services providers in hiring highly competent employees. There can be no assurance that we will succeed in attracting, integrating and retaining appropriately qualified personnel. We are exposed to new risks as we expand our businesses, the range of our products and services, and geographic scope of our businesses overseas. As part of our business strategies we have expanded and may continue to expand our businesses or our range of products and services beyond our core business, commercial banking. This could expose us to new risks, such as adverse regulatory changes, more competition or a decline in the operating environments that affect those businesses, products and services. Some of those risks could be types with which we have no or only limited experience. As a result, our risk management systems may prove to be insufficient and may not be effective in all cases or to the degree required.
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Table of ContentsIn accordance with our strategy to further increase our presence in the international financial markets, we may continue to expand the scale of our overseas businesses, especially in emerging economies, notably Asian countries. The expansion of our overseas businesses may further increase our exposure to risks of adverse developments in foreign economies and markets, including interest rate and foreign exchange rate risk, regulatory risk and political risk. Our overseas expansion also exposes us to the compliance risks and the credit and market risks specific to the countries and regions in which we operate, including the risk of deteriorating conditions in the credit profile of overseas borrowers. Failure of our business strategies through our subsidiaries, affiliates and other business alliance partners could negatively affect our financial condition and operating results, including impairment losses on goodwill or investments. As part of our business strategies, we have made and may undertake acquisition of a subsidiary and investments in affiliates and other business alliance partners in the banking, securities, consumer finance, credit card, leasing and asset management businesses. It is uncertain whether we will receive the expected benefits from those business strategies, due to any adverse regulatory changes, worsening of economic conditions, competition or other factors that may negatively affect the related business activities. Furthermore, unanticipated costs and liabilities may be incurred in connection with those business strategies, including claims related to the businesses prior to our business alliances, and actions by regulatory authorities. When we acquire a subsidiary, we may recognize some goodwill and intangible assets. Impairment losses on goodwill or intangible assets in connection with acquisitions must be recognized when the recoverable amount of goodwill or intangible assets of the business is lower than the carrying amount at the time of impairment testing, which is performed annually or whenever there is an indication that the goodwill or intangible assets may be impaired. We account for some of our investments in affiliates under the equity method. Net losses by equity method investees may cause us to record our share of net losses of the affiliates. Furthermore, we may lose the capital which we have invested in business alliances or may incur impairment losses on securities acquired in such alliances. We may also be required under contractual or other arrangements to provide financial support, including credit support and equity investments, to business alliance partners in the future. We may also incur credit costs from our credit exposure to such partners. We are exposed to the industry specific risks of the consumer finance industry. Changes in the legal environment have severely adversely affected the business performance of consumer finance and credit card companies. We have exposures to those associated risks through our subsidiaries, including Cedyna Financial Corporation (“Cedyna”) and SMBC Consumer Finance Co., Ltd. (“SMBC Consumer Finance”), formerly known as Promise Co., Ltd. and which became our subsidiary on December 7, 2011. Consumer finance and credit card companies had offered unsecured personal loans, which included so-called “gray zone” interest on loans in excess of the maximum rate prescribed by the Interest Rate Restriction Act (ranging from 15% to 20%) up to the 29.2% maximum rate permitted under the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates (“Contributions Act”). However, as a result of court decisions unfavorable to those companies, claims for refunds of amounts paid in excess of the applicable maximum allowed rate by the Interest Rate Restriction Act have increased substantially. Although SMBC Consumer Finance, Cedyna and other subsidiaries have each recorded a provision for claims for refunds of gray zone interest on loans, we may be required to recognize additional losses if such provisions are determined to be insufficient. Amendments to laws regulating moneylenders, which were promulgated in 2006 and which became fully effective in June 2010, increased the authority of government regulators, prohibited gray zone interest and
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Table of Contentsintroduced an upper limit on aggregate credit extensions to an individual by moneylenders at one-third of the borrower’s annual income. After the promulgation of such amendments, SMBC Consumer Finance, Cedyna and other companies engaged in related business reduced their interest rates on loans in preparation for the prohibition of gray zone interest. As a consequence, margins earned by those companies, as well as the amounts of loans extended, have decreased. An inability to generate sufficient future taxable profits or adverse changes to tax laws, regulatory requirements or accounting standards could have a negative impact on the recoverability of certain deferred tax assets. We recognize deferred tax assets relating to tax losses carried forward and deductible temporary differences only to the extent that it is probable that future taxable profit will be available against which the tax losses carried forward and the temporary differences can be utilized. Net deferred tax assets amounted to ¥563 billion and ¥1,001 billion at March 31, 2012 and 2011, respectively. Net deferred tax assets are quantified on the basis of current tax rates and accounting standards and are subject to change as a result of changes to future tax rates or the rules for computing taxable profits and allowable losses. Failure to generate sufficient future taxable profits or changes in tax laws or accounting standards may reduce our estimated recoverable amount of net deferred tax assets. Such a reduction could have an adverse effect on our financial condition and results of operations. Declines in actual returns on our plan assets or revised actuarial assumptions for retirement benefits may adversely affect our financial condition and results of operations. The Bank and some of our subsidiaries have various defined benefit plans. We have experienced in the past, and may experience in the future, declines in actual returns on plan assets and changes in the discount rates and other actuarial assumptions. If actual returns on plan assets are lower than expected returns on plan assets or if we revise the discount rates and other assumptions, we may incur actuarial losses which may have an adverse effect on our financial condition and results of operations. Unrecognized actuarial losses may be recognized as losses in future periods. Because approximately half of our plan assets are composed of equity instruments, the plan assets are greatly affected by volatility in the prices of equity securities. Substantial declines in the prices for publicly traded Japanese stocks would negatively affect our plan assets and unrecognized losses arising from such declines may be recognized as losses in future periods. For further information, see Note 23 “Retirement Benefits” to our consolidated financial statements included elsewhere in this annual report. Our business relies on our information technology systems, and their failure could harm our relationships with customers or adversely affect our provision of services to customers. In all aspects of our business, we use information technology systems to deliver services to and execute transactions on behalf of our customers as well as for back-office operations. We therefore depend on the capacity and reliability of the electronic and information technology systems supporting our operations. We may encounter service disruptions in the future, owing to failures of these information technology systems. Our information technology systems are subject to damage or incapacitation as a result of quality problems, human errors, natural disasters, power losses, sabotage, computer viruses, acts of terrorism and similar events. While we have taken steps to protect information technology systems from those risks, including by establishing data recovery capability and functionality, these measures may not be sufficient. In addition, we may not be prepared to address all contingencies that could arise in the event of a major disruption of services. The failure to address such contingencies could harm our relationships with customers or adversely affect our provision of services to customers. We handle personal information obtained from our individual and corporate customers in relation to our banking, securities, credit card, consumer finance and other businesses. The systems we have implemented to protect the confidentiality of personal information, including those designed to meet the strict requirements of the Act Concerning Protection of Personal Information, may not be effective in preventing disclosure of personal
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Table of Contentsinformation by unauthorized access from a third party. Leakage of personal information could expose us to demands for compensation or lawsuits for ensuing economic losses or emotional distress, administrative actions or sanctions, additional expenses associated with making necessary changes to our systems and reputational harm. As a result, our business, financial condition and results of operations could be materially and adversely affected. Our risk management policies and procedures may not adequately address unidentified or unanticipated risks. We are exposed to a variety of operational, legal and regulatory risks throughout our organization. Management of these risks requires, among other things, policies and procedures to properly record and verify large numbers of transactions and events. However, these policies and procedures may not be fully effective or sufficient. We have devoted significant resources to strengthening our risk management policies and procedures and expect to continue doing so in the future. Nevertheless, particularly in light of the continuing evolution of our operations and expansion into new areas, our policies and procedures designed to identify, monitor and manage risks may not be fully effective. Some of our methods of managing risks are based upon our use of observed historical market behavior and thus may not accurately predict future risks. Violations of laws including the Japanese antitrust and fair trade laws by us or by the Bank may result in administrative sanctions. Furthermore, investigations, administrative actions or litigation could commence in relation to violations, which may involve costs and may result in deterioration of our reputation. Fraud or other misconduct by directors, officers and employees or third parties could subject us to losses and regulatory sanctions. We are exposed to potential losses resulting from fraud, misconduct and other unlawful behavior by directors, officers and employees. Directors, officers and employees may bind us to transactions that exceed authorized limits or present unacceptable risks, hide from us and from our customers unauthorized activities, improperly use confidential information or otherwise abuse customer confidences. Third parties may engage in fraudulent activities, including fraudulent use of bank accounts or the use of false identities to open accounts for money laundering, tax evasion or other illegal purposes. Third parties could also use stolen or forged ATM cards or engage in credit card fraud, and we may be required to indemnify victims of such fraud for related losses. In the broad range of businesses in which we engage, fraud, misconduct and other unlawful behavior are difficult to prevent or detect. In addition, with or without actual fraud, misconduct and other unlawful behavior by directors, officers and employees, investigations, administrative actions or litigation could commence in relation to them. Furthermore, we may not be able to recover the losses caused by these activities, including possible deterioration of our reputation. Transactions with counterparties in Iran and other countries designated by the U.S. Department of State as state sponsors of terrorism or that are subject to other U.S. economic sanctions may lead some potential customers and investors to avoid doing business with us or investing in our securities or may limit our business operations. U.S. law generally prohibits or substantially restricts U.S. persons from doing business with countries designated by the U.S. Department of State as state sponsors of terrorism (“Designated Countries”), which currently are Cuba, Iran, Sudan and Syria. Under U.S. law, there are similar prohibitions or restrictions on countries that are the subject of other U.S. economic sanctions administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) or other agencies (collectively with the Designated Countries, the “Restricted Countries”). We maintain a Group-wide policy designed to ensure compliance with applicable U.S. laws and regulations. This policy, which covers the Bank and our banking subsidiaries that provide financial services globally, prohibits the new extension of credit to Iranian entities. Our non-U.S. offices engage in transactions relating to the Restricted Countries on a limited basis and in compliance with applicable laws and regulations. These include remittance of Japanese yen with respect to our customers’ export or import
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Table of Contentstransactions, maintenance of correspondent banking accounts and inter-bank money market transactions with Iranian banks, including those which OFAC identifies as “Specially Designated Nationals.” In addition, we maintain a representative office in Iran that mainly performs an information-collecting function. We do not believe that our operations relating to the Restricted Countries materially affect our business, financial condition or results of operations. A limited number of the Bank’s transactions with Cuba, Iran, Sudan and certain other countries that are the subject of U.S. economic sanctions were identified and voluntarily disclosed to OFAC. These transactions resulted from inadvertent operational errors or the lack of familiarity of some Bank personnel with the requirements of the relevant regulations in the past. Since the discovery of these potential violations we have further strengthened our Group-wide OFAC compliance program in an effort to prevent the recurrence of such potential violations. We settled some of the disclosed potential violations with OFAC while others remain unsettled. However, in light of the inadvertent nature of such potential violations and the degree to which our strengthened OFAC compliance program aims to mitigate the risk of potential violations, we do not believe that our settlement with OFAC or any possible penalties that OFAC may impose with respect to the other potential violations that remain unsettled will have a material impact on our reputation, financial condition or results of operations or on the prices of our securities. We are aware of initiatives by U.S. governmental entities and U.S. institutional investors, such as pension funds, to adopt laws, regulations or policies prohibiting transactions with or investment in, or requiring divestment from, entities doing business with Iran and other Designated Countries. It is possible that such laws and initiatives may result in our inability to enter into transactions with those entities that are subject to such prohibitions or to retain or acquire such entities as customers or investors in our securities. In addition, depending on sociopolitical developments, our reputation may suffer due to our association with the Designated Countries. The above circumstances could have a significant adverse effect on our business or the prices of our securities. In July 2010, the U.S. government enacted legislation designed to restrict economic and financial transactions with Iran, i.e., the Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010 (“CISADA”), which may lead to the imposition of sanctions against non-U.S. financial institutions, such as us, if they are determined by the Secretary of the Treasury to have facilitated “significant transactions” or provided “significant financial services” for certain Iran-linked financial institutions or the Iranian Revolutionary Guard Corps. In addition, the U.S. government broadened the range of sanctionable transactions to include conducting or facilitating “significant financial transactions” with the Central Bank of Iran or certain other Iranian financial institutions by adopting Section 1245 of the National Defense Authorization Act for Fiscal Year 2012 (the “NDAA”), as implemented by Executive Order 13599 of February 5, 2012 and by amending the Iranian Financial Sanctions Regulations on February 27, 2012. These or similar legislative or regulatory developments may further limit our business operations. Specifically, we could lose our ability to maintain correspondent or payable-through accounts with U.S. financial institutions in case we are determined to have engaged in activities targeted by CISADA or the NDAA. The U.S. Secretary of State announced on March 20, 2012 that Japan is among a group of countries that has significantly reduced the volume of crude oil purchases from Iran, and that therefore the NDAA sanctions would not apply to Japanese financial institutions for a period of 180 days, which period is renewable based on ongoing reductions in crude oil purchases from Iran. There is no guarantee that the U.S. Secretary of State will renew this waiver with respect to Japanese financial institutions. This or similar legislative developments may further affect our business operations. Our business could be adversely affected by litigation and regulatory proceedings globally. We conduct business in many locations in and outside of Japan. We face the risk of litigation and regulatory proceedings in connection with our operations. For example, if we engage in activities targeted by CISADA or the NDAA, this could result in the imposition of sanctions by the U.S. government against us. Lawsuits and regulatory actions may result in sanctions of very large indeterminate amounts or limit our operations, and costs
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Table of Contentsto defend either could be substantial. Moreover, the Bank and one of its subsidiaries contribute to financial benchmarks such as the Tokyo Interbank Offered Rate and the London Interbank Offered Rate for certain specific currencies. These benchmarks are used in jurisdictions in which we operate and do not operate. We face or may face some investigations, litigation and regulatory proceedings, and an adverse regulatory decision, judgment or ruling, including in jurisdictions we do not operate in, could have a material adverse effect on our business, operating results and financial condition. Risks Related to Our Industry Our liquidity could be adversely affected by actual or perceived weaknesses in our businesses and by factors we cannot control, such as a general decline in the level of business activity in the financial services sector. We need liquidity to pay our operating expenses, pay interest on and principal of debt and dividends on capital stock, maintain our lending activities and meet deposit withdrawals. Adverse market and economic conditions in the domestic and global economies may limit or adversely affect our access to liquidity required to operate our business. If our counterparties or the markets are reluctant to finance our operations due to factors including actual or perceived weaknesses in our businesses as a result of large losses, changes in our credit ratings, or a general decline in the level of business activity in the financial services sector, we may be unable to meet our payment obligations when they become due or only be able to meet them with funding obtained on unfavorable terms. Circumstances unrelated to our businesses and outside our control, such as, but not limited to, adverse economic conditions, disruptions in the financial markets or negative developments concerning other financial institutions perceived to be comparable to us, may also limit or adversely affect our ability to replace maturing liabilities in a timely manner. Without sufficient liquidity, we will be forced to curtail our operations, and our business and our operating results and financial condition could be adversely affected. We may incur losses as a result of financial difficulties of counterparties and other financial institutions. We regularly execute transactions with counterparties in the financial services industry. Many of these transactions expose us to credit risk in the event of deterioration of creditworthiness of a counterparty or client. With respect to secured transactions, our credit risk may be exacerbated when the collateral cannot be foreclosed on or is liquidated at prices not sufficient to recover the full amount of the loan or other exposures due to us. Losses from our investments in and loans to other financial institutions could materially and adversely affect our business, financial condition and results of operations. We may also be requested to participate in providing assistance to distressed financial institutions that are not our consolidated subsidiaries. In addition, if the funds collected by the Deposit Insurance Corporation of Japan (“DIC”) are insufficient to insure the deposits of failed Japanese banks, the insurance premiums that we pay to the DIC will likely be increased, which could adversely affect our business and operating results. Adverse regulatory developments or changes in government policies could have a negative impact on our results of operations. Our businesses are subject to extensive regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies, voluntary codes of practice and interpretations in Japan and the other jurisdictions in which we operate. Those changes and their effects on us are unpredictable and beyond our control. Changes in the regulatory environment may adversely affect our financial condition and results of operations. In particular, the financial crisis has led to calls for significant financial reform measures, and various governments are at different stages of enacting legislation that will affect financial institutions. In response to the financial and economic turmoil, regulatory authorities have been reviewing and revising capital adequacy guidelines, particularly in relation to quality of capital and accounting standards; such revisions
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Table of Contentscould adversely affect our capital ratios. In December 2010, the Basel Committee published the Basel III rules text, setting out certain changes to capital requirements which include raising the quality of banks’ capital bases, enhancing risk coverage, inhibiting leverage, reducing pro-cyclicality and introducing liquidity regulation. The changes that FSA made to its capital adequacy guidelines in response to Basel III will be generally applied from March 31, 2013. The FSA’s Financial Inspection Manual for financial institutions and related guidelines are revised or amended from time to time. Our implementation of any such changes could result in an increase in our administrative expenses, which could have an adverse effect on the results of operations and financial condition of us and the Bank. The FSA and regulatory authorities in the United States and other jurisdictions, along with the United Nations, have in recent years made sanctions as a means to promote the prevention of money laundering and terrorism financing a focus of governmental policy relating to financial institutions. Any regulatory action or change in regulatory focus, whether as a result of inspections or regulatory developments, may negatively affect our banking operations and may require expensive remediation. The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which was enacted in July 2010, provides a broad framework for significant regulatory changes across most areas of U.S. financial regulations. The Dodd-Frank Act addresses, among other issues, systemic risk oversight, bank capital standards, over-the-counter (“OTC”) derivatives, the ability of banking entities to engage in proprietary trading activities and invest in hedge funds and private equity funds (known as the “Volcker Rule”) and securitization. Implementation of the Dodd-Frank Act is taking place through detailed rulemaking over multiple years by various regulators. Although the final details, impact and timing of the rules remain uncertain, it could result in additional costs, or restrict or otherwise affect the way we conduct our business. These and similar, or any other kind of significant regulatory developments could adversely affect our capital ratios and operating results. For further details, see “Item 4.B. Business Overview—Regulation.” Since those changes in regulation or fiscal or other policies and their effects are unpredictable and beyond our control, we may be unable to comply with those changes regardless of our efforts. Any such failures could result in administrative or judicial proceedings against us, including suspension of our business and financial penalties, which could materially adversely affect our business, reputation, operating results and financial condition. We operate in the highly competitive financial services industry. Deregulation, consolidation among financial institutions, diversification within the financial services industry and the expanded presence of foreign financial institutions and investors have made the Japanese financial services market highly competitive. Moreover, competition in overseas markets has intensified due to global consolidation, convergence and alliances among financial institutions. We compete with various types of financial services companies, including:
Government actions, such as those taken to stabilize the market and to alter the regulatory framework, may affect our competitive position. In response to the recent financial crisis, the Government of Japan has taken and may adopt policies, including providing fiscal stimulus or extending credit support to other Japanese financial
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Table of Contentsinstitutions, which adversely affect our competitive position. For example, the National Diet of Japan (“Diet”) enacted a bill that allowed the Japan Post Bank Co., Ltd., one of the world’s largest deposit-taking financial institutions, to expand its business upon notification to and without future approval of the government. Increased competition in Japan may put downward pressure on prices for our financial services, cause us to lose market share or require us to incur additional expenses in order to remain competitive. Internationally, various forms of financial support provided by foreign governments to foreign banks and other financial institutions during the current financial crisis may reduce the cost of capital to those institutions and otherwise give them competitive advantages. There can be no assurance that we will be able to respond effectively to current or future competition. Damage to our reputation may have an adverse effect on our business and operating results. Maintaining our reputation is vital to our ability to attract and maintain customers, investors and employees. Our reputation could be damaged through a variety of circumstances, including, among others, fraud or other misconduct or unlawful behavior by directors, officers or employees, systems failures, compliance failures, investigations, adverse litigation judgments or regulatory decisions, or unfavorable outcomes of governmental inspections. Negative media coverage of Japan’s financial services industry or us, even if inaccurate or not applicable to us, may have a materially adverse effect on our brand image and may undermine depositor confidence, thereby affecting our businesses and results of operations. For example, actual or rumored investigations of us or our directors, officers or employees, or actual or rumored litigation or regulatory proceedings, or media coverage of the same, may have a material adverse effect on our reputation and could negatively affect the prices of our securities. Actions by the financial services industry generally or by certain members in the industry can also adversely affect customers’ confidence on the financial services industry. Such reputational harm could also lead to a decreased customer base, reduced revenues and higher operating costs. Other Risks Our failure to establish, maintain and apply adequate internal controls over financial reporting could negatively impact investor confidence in the reliability of our financial statements. In order to operate as a global financial institution, it is essential for us to have effective internal controls, corporate compliance functions, and accounting systems to manage our assets and operations. As a New York Stock Exchange-listed company and a registrant with the U.S. Securities and Exchange Commission (“SEC”) under section 404 of the U.S. Sarbanes-Oxley Act of 2002, our management is required to assess the effectiveness of our internal control over financial reporting and disclose whether such internal controls are effective. Our independent registered public accounting firm has to conduct an audit to evaluate and then render an opinion on the effectiveness of our internal control over financial reporting. The Financial Instruments and Exchange Act of Japan (“FIEA”) also requires us, as a company listed on a Japanese stock exchange, to file, together with our annual securities reports required by the FIEA, audited internal control reports assessing the effectiveness of our internal controls over financial reporting. We have established internal controls over financial reporting, as well as rules for evaluating those controls, in order to provide reasonable assurance of the reliability of our financial reporting and the preparation of financial statements. However, these controls may not prevent or detect errors. Any evaluation of effectiveness to future periods is subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. To the extent any issues are identified through the foregoing processes, there can be no assurance that we will be able to resolve them in a timely manner or at all. If this occurs, our reputation may be damaged, which could lead to a decline in investor confidence in us.
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Table of ContentsOur business operations are exposed to risks of natural disasters, terrorism, pandemics and other calamities. Our business operations are subject to the risks of natural disasters, terrorism, pandemics, blackouts, geopolitical incidents and other calamities, any of which could impair our business operations. Despite our preparation of operation manuals and other backup measures and procedures, such calamities could cause us to suspend operations and could adversely affect our businesses, financial condition and results of operations. Massive natural disasters such as the Great East Japan Earthquake and any subsequent collateral events, may adversely affect economic conditions in general, the financial conditions of our corporate and individual customers and stock market prices, or cause other negative effects, any or all of which could materially and adversely affect our financial condition and results of operations owing to, for example, an associated increase in the amount of credit-related costs or an increase in losses related to our holdings of securities. Sales of shares by us or the Bank may have an adverse effect on the market price of our shares and may dilute existing shareholders. We may issue shares from the unissued portion of our authorized share capital and sell shares held as treasury stock, generally without a shareholder vote. In addition, the Bank may sell any of our shares that it holds. Sales of shares in the future may be at prices below prevailing market prices and may be dilutive. It may not be possible for investors to effect service of process within the United States upon us or our directors, corporate auditors or senior management, or to enforce against us or those persons judgments obtained in U.S. courts predicated upon the civil liability provisions of the U.S. federal or state securities laws. We are a joint stock corporation incorporated under the laws of Japan. Almost all of our directors, corporate auditors and senior management reside outside the United States. Many of our assets and the assets of these persons are located in Japan and elsewhere outside the United States. It may not be possible, therefore, for U.S. investors to effect service of process within the United States upon us or these persons or to enforce, against us or these persons, judgments obtained in U.S. courts predicated upon the civil liability provisions of the federal or state securities laws. We believe that there is doubt as to the enforceability in Japan, in original actions or in actions to enforce judgments of U.S. courts, of claims predicated solely upon the U.S. federal or state securities laws mainly because the Civil Execution Act of Japan requires Japanese courts to deny requests for the enforcement of judgments of foreign courts if foreign judgments fail to satisfy the requirements prescribed by the Civil Execution Act, including requirements that:
Judgments obtained in U.S. courts, predicated upon the civil liability provisions of the U.S. federal or state securities laws, may not satisfy these requirements. As a holder of our American Depositary Shares (“ADSs”), you have fewer rights than a shareholder of record in our shareholder register because you must act through the depositary to exercise these rights. The rights of our shareholders under Japanese law to take actions such as voting their shares, receiving dividends and distributions, bringing derivative actions, examining our accounting books and records and
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Table of Contentsexercising appraisal rights are available only to our shareholders of record. Because the depositary, through its custodian, is the record holder of the shares underlying the ADSs, only the depositary can exercise shareholder rights relating to the deposited shares. ADS holders will not be able to directly bring a derivative action, examine our accounting books and records or exercise appraisal rights. Pursuant to the deposit agreement among us, the depositary and the holders and beneficial owners of ADSs, the depositary will endeavor to exercise voting and other rights associated with shares underlying ADSs in accordance with instructions given by ADS holders, and the depositary will also pay to ADS holders dividends and distributions collected from us. However, the depositary is permitted under the deposit agreement to exercise reasonable discretion in carrying out those instructions or in making distributions, and is not liable for failure to carry out instructions or make distributions as long as it acts in good faith. Therefore, ADS holders may not be able to exercise voting or other rights associated with the shares underlying ADSs in the manner that they intend, or may lose some or all of the value of dividends or distributions collected from us. Moreover, the deposit agreement may be amended or terminated by us and the depositary without any reason, or consent from or notice to ADS holders. As a result, ADS holders may not be able to exercise rights in connection with the deposited shares exercised in the way they wish or at all. ADS holders are dependent on the depositary for certain communications from us. We send to the depositary most of our communications to ADS holders in Japanese. ADS holders may not receive all of our communications in the same manner as or on an equal basis with shareholders of record in our shareholder register.
4.A. HISTORY AND DEVELOPMENT OF THE COMPANY Legal and Commercial Name Our legal name is Sumitomo Mitsui Financial Group, Inc. Our commercial name is Sumitomo Mitsui Financial Group (“SMFG”). Date of Incorporation We were established in December 2002. Domicile and Legal Form We are a joint stock corporation incorporated with limited liability under the laws of Japan. Our address is: Sumitomo Mitsui Financial Group, Inc., 1-2, Marunouchi 1-chome, Chiyoda-ku, Tokyo 100-0005, Japan. Our telephone number is: +81-3-3282-8111. History and Development We were established in December 2002 as a holding company for the Group through a statutory share transfer (kabushiki-iten) of all of the outstanding equity securities of the former SMBC in exchange for our newly issued securities. Upon our formation and completion of the statutory share transfer, the former SMBC became our direct, wholly owned subsidiary. The Bank was established in March 2003 through the merger of the former SMBC with Wakashio Bank, which was established in 1996 as a subsidiary of Sakura Bank. The former SMBC was established in April 2001 through the merger of Sumitomo Bank and Sakura Bank, which was established through the merger of Taiyo Kobe Bank and Mitsui Bank in 1990. Mitsui and Sumitomo started their banking businesses in 1876 and 1895, respectively. The origins of both banking businesses can be traced back to the seventeenth century.
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Table of ContentsInformation Concerning the Principal Capital Expenditures and Divestitures In July 2009, the Bank invested ¥27 billion to acquire a 51% interest in ORIX Credit Corporation, a consumer finance provider, which became a consolidated subsidiary of the Bank with ORIX Corporation owning the remaining 49%. In October 2009, we acquired for ¥565 billion all the operations of the former Nikko Cordial Securities Inc. and a part of the operations of the former Nikko Citigroup Ltd., which have since been combined to form SMBC Nikko Securities Inc. In December 2009, we terminated a joint business with Daiwa Securities Group Inc. and sold to Daiwa Securities Group our 40% equity interest in the former Daiwa Securities SMBC Co., Ltd., now Daiwa Securities Co. Ltd. In May 2010, our wholly owned subsidiary, SMFG Card & Credit, Inc., subscribed for a third-party allotment of newly-issued shares of Cedyna’s common stock for a total price of approximately ¥50 billion. As a result, Cedyna, previously our equity-method associate, became our consolidated subsidiary. In May 2011, SMFG Card & Credit completed a share exchange to acquire the remaining outstanding shares of Cedyna, and Cedyna became our wholly owned subsidiary. In December 2011, the Bank made SMBC Consumer Finance, formerly known as Promise, its consolidated subsidiary with the completion of a tender offer for an aggregate ¥71 billion. Following the tender offer, in the same month, we subscribed for a third-party allotment of newly issued shares of SMBC Consumer Finance’s common stock for a total price of ¥120 billion. On April 1, 2012, SMBC Consumer Finance became our wholly owned subsidiary upon the completion of a share exchange of our common stock for SMBC Consumer Finance’s common stock, including the shares which the Bank owned. On June 1, 2012, the Bank, Sumitomo Mitsui Finance and Leasing and Sumitomo Corporation, a non-affiliate, acquired the aircraft leasing business of The Royal Bank of Scotland Group plc, and commenced its operation as SMBC Aviation Capital. The final purchase price has not yet been finalized because it will be adjusted based on the assets and liabilities of the acquired business at May 31, 2012. On June 29, 2012, the Bank transferred all of its shares of ORIX Credit to ORIX and, as a result, ORIX Credit is no longer our subsidiary. Public Takeover Offers Not applicable. Overview We are a holding company that directly owns 100% of the issued and outstanding shares of the Bank, one of the largest commercial banks in Japan. We are one of the three largest banking groups in Japan with an established presence across all of the consumer and corporate banking sectors. Our subsidiaries in our commercial banking business include, in addition to SMBC, Kansai Urban Banking Corporation, The Minato Bank, Sumitomo Mitsui Banking Corporation Europe Limited (“SMBC Europe”) and Sumitomo Mitsui Banking Corporation (China) Limited (“SMBC (China)”). Our subsidiaries also include SMBC Nikko Securities and SMBC Friend Securities Co., Ltd. in our securities business; Sumitomo Mitsui Finance and Leasing Company, Limited in our leasing business; and Sumitomo Mitsui Card Company, Limited and Cedyna in our credit card services business. See “Item 4.C. Organizational Structure.”
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Table of ContentsManagement Philosophy Our Group-wide management philosophy is as follows:
In addition to our Group-wide management philosophy, we have also established a code of conduct. Our code of conduct is designed to be a guideline for the conduct of our directors, officers and other employees in the realization of our Group-wide management philosophy in all areas. Our code of conduct is as follows:
Environment We recognize preservation of the environment as one of our most important management objectives and strive to achieve harmony with the natural environment in our corporate activities. Basic Philosophy Regarding the Group’s Environmental Activities Recognizing the importance of realizing a sustainable society as one of our most important tasks, we make continuous efforts to harmonize environmental preservation and corporate activities in order to support the economy and contribute to the general well-being of society as a whole. We and our principal Group companies have obtained ISO 14001 certification, the international standard for environmental management systems. Every year we set environmental objectives which we systematically pursue through environmental activities based on a PDCA (Plan, Do, Check and Act) cycle. We officially signed the “Statement by Financial Institutions on the Environment and Sustainable Development” of the United Nations Environment Programme (“UNEP”) in 2002.
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Table of ContentsThe Bank made its head office “carbon neutral” and requires land pledged as collateral to undergo soil contamination and asbestos risk assessment. In addition, we also apply the “Equator Principles,” a set of guidelines for financial institutions to assess and manage social and environmental impacts related to the financing of large-scale development projects, when we finance such projects. Description of Operations and Principal Activities Commercial Banking We offer commercial banking services to a wide range of customers including individuals, mid-sized companies, small and medium-sized enterprises (“SMEs”), large corporations, governments and governmental entities mainly through the Bank. The Bank has solid franchises in both corporate and consumer banking in Japan. The Bank has long-standing and close business relationships with many companies listed on the First Section of the Tokyo Stock Exchange and long historical relationships with the so-called Sumitomo Group and Mitsui Group companies. The Bank provides an extensive range of consumer and corporate banking services in Japan and wholesale banking services overseas. In Japan, the Bank accepts deposits from, makes loans to, extends guarantees to and provides other products and services to corporations, individuals, governments and governmental entities. The Bank offers financing solutions through loan syndication, structured finance and project finance to large corporate customers in the domestic and overseas markets, as well as a variety of financing options to domestic mid-sized companies, SMEs and individuals. The Bank also underwrites and deals in bonds issued by or guaranteed by the Government of Japan and local government authorities, and acts in various administrative and advisory capacities for select types of corporate and government bonds. Internationally, the Bank operates through a network of branches, representative offices, subsidiaries and affiliates to provide loan syndication, project finance and cash management services and participate in international securities markets. The Bank conducts its primary banking business through its five business units: the Consumer Banking Unit, the Middle Market Banking Unit, the Corporate Banking Unit, the International Banking Unit and the Treasury Unit. The Bank’s Investment Banking Unit, Corporate Advisory Division, Private Advisory Division and Transaction Business Division operate across these business units. Further, the Bank has a Corporate Staff Unit, a Corporate Services Unit, a Compliance Unit, a Risk Management Unit and an Internal Audit Unit. The Bank’s Consumer Banking Unit The Bank’s Consumer Banking Unit provides financial services to consumers residing in Japan. It offers a wide array of financial services including, but not limited to, personal bank accounts, investment trusts, pension-type insurance products, life insurance products and housing loans. The operations are mainly conducted through a large and well developed branch network. The Bank had a domestic network consisting of 437 branch offices at March 31, 2012, most of which were located in the Tokyo and Osaka regions. At March 31, 2012, 73 of these branches had “SMBC Consulting Plazas” that provide financial consulting services about asset management and housing loans during extended hours, including weekday evenings, weekends and national holidays, for the convenience of individual customers. The Bank also operates an extensive network of ATMs in Japan. At March 31, 2012, the Bank offers its customers’ access to 43,824 ATMs, some of which are the Bank’s ATMs and the majority of which are ATMs made available through arrangements with other ATM providers such as convenience store chains. The Consumer Banking Unit also offers internet banking services for consumers. At March 31, 2012, the Bank’s internet banking services had approximately 12 million registered users. The users are able to transfer funds, perform balance inquiries, make time deposits and foreign currency deposits and buy and sell investment trusts over the internet, as well as over the mobile phone or the traditional telephone.
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Table of ContentsThis business unit offers deposit products, including ordinary deposits and time deposits, and the following products and services through various channels:
The Bank also offers the wealth management services to its customers in collaboration with SMBC Nikko Securities and Barclays PLC. See “—Alliance with Barclays.” The Bank’s Middle Market Banking Unit The Bank’s Middle Market Banking Unit focuses on building a solution business and responding to various issues which mid-sized companies and SMEs face. This business unit, together with certain of our Group companies, offers its customers lending, cash management, settlement, leasing, factoring, management information systems consulting, collection and investment banking services, through 223 sales channels of the Bank at March 31, 2012. This business unit also provides the following products and services to mid-sized companies and SMEs:
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Table of ContentsThe Bank’s Corporate Banking Unit The Bank’s Corporate Banking Unit provides a wide range of financial products and services such as loans, deposits and settlement services, targeting large Japanese corporations and listed companies. This business unit also offers business solutions for the increasingly complex and diverse management issues which large Japanese corporations are currently facing, and supports their active business expansion plans. This business unit, with the Bank’s Investment Banking Unit, provides products and services such as loan syndication, structured finance, commitment lines and non-recourse loans. As part of its solutions services, the Bank intends to promote opportunities for the capital markets to respond to its customers’ funding and corporate restructuring needs, particularly through SMBC Nikko Securities. The Bank’s International Banking Unit The Bank’s International Banking Unit mainly supports companies, financial institutions, sovereign/quasi-sovereign entities outside Japan, and multinational companies operating in Japan. This business unit provides a variety of tailored products and services to meet customer and market requirements, including loans, deposits, clearing services, trade finance, project finance, loan syndication and global cash management services. At March 31, 2012, the Bank’s international network consisted of 15 branches, 10 sub-branches and 10 representative offices and together with the network of its subsidiaries such as SMBC Europe and SMBC (China), the Bank seeks to meet customers’ needs globally. After April 2011, the Bank newly established representative offices in:
Based on our strategy of expanding our businesses globally, the Bank has been promoting strategic alliances to enhance products and services with leading financial institutions such as Barclays, Vietnam Export Import Commercial Joint Stock Bank, The Bank of East Asia Limited, Kookmin Bank and Kotak Mahindra Bank Limited. The Bank’s Treasury Unit The Bank’s Treasury Unit operates in the domestic and international money, foreign exchange, securities and derivatives markets to serve customer needs and the Bank’s own asset and liability management requirements. To further expand the Bank’s customer base, this business unit also seeks to provide specialized solutions and enhance customer service capabilities in market transactions through the following activities:
This business unit also provides underwriting services for the placement of commercial paper.
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Table of ContentsOthers The Bank also engages in the following business activities through its business units:
In cooperation with the Bank’s business units and SMBC Nikko Securities, the Bank also engages in the following business activities:
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In addition to the Bank, our domestic banking subsidiaries include local financial institutions, such as Kansai Urban Banking Corporation and The Minato Bank, as well as The Japan Net Bank, Limited. Kansai Urban Banking Corporation and The Minato Bank, as regional financial institutions based in Kansai area, provide commercial banking services to corporations and individuals. The Japan Net Bank, as an internet bank, provides internet-based services such as deposits, loans and investment products. Our foreign banking subsidiaries include SMBC Europe, SMBC (China), Manufacturers Bank, Sumitomo Mitsui Banking Corporation of Canada, Banco Sumitomo Mitsui Brasileiro S.A., ZAO Sumitomo Mitsui Rus Bank, PT Bank Sumitomo Mitsui Indonesia and Sumitomo Mitsui Banking Corporation Malaysia Berhad. At March 31, 2012, in China there are 15 offices which are composed of eight branches including the head office and four sub-branches of SMBC (China), and one branch and two representative offices of the Bank. Securities SMBC Friend Securities SMBC Friend Securities, our wholly owned subsidiary, is a full-line securities company focusing on retail business. SMBC Friend Securities has a nationwide network that offers services tailored to the needs of its clients and offers online financial consulting services. SMBC Nikko Securities As one of the major Japanese securities companies, SMBC Nikko Securities offers a wide range of financial products and investment consultation and administrative services to its individual and corporate customers in Japan. For individual customers, SMBC Nikko Securities provides consulting services to meet diversified asset management needs at 109 branches nationwide, and a widely used online trading tool. For corporate customers, it also offers trading capabilities and financial products, debt and equity underwriting, and M&A advisory services, mainly in Japan. In October 2009, SMBC Nikko Securities was formed as a wholly owned subsidiary of the Bank through the Bank’s acquisition of all the shares of Nikko Cordial Securities Inc., which engaged mainly in the retail business, and the domestic debt and equity underwriting and certain other businesses of Nikko Citigroup Ltd., which engaged mainly in the wholesale business. SMBC Nikko Securities, together with its overseas subsidiaries, SMBC Nikko Securities (Hong Kong) Limited, SMBC Nikko Capital Markets Limited and SMBC Nikko Securities America, Inc., seeks to provide financial services such as brokerage services of Japanese stocks and M&A advisory services to clients on a global basis. To strengthen our cross border M&A and other advisory services to Japanese companies, SMBC Nikko Securities, the Bank and Moelis & Company, a global investment bank headquartered in New York, established a business alliance in March 2011. In February 2012, we invested approximately $93 million in Moelis & Company to enhance the existing business alliance. Business Alliance with Citigroup In May 2009, we entered into a strategic business alliance with Citigroup Inc. centering on a variety of collaborative activities between SMBC Nikko Securities and Citigroup. As part of this alliance, Citigroup
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Table of Contentsprovides us with access to its global corporate and investment banking networks, including sales and trading and M&A services. The long-standing relationship between Citigroup and the former Nikko Cordial Securities in the origination and distribution of financial products in Japan and globally is being upheld with SMBC Nikko Securities. Termination of Our Alliance with Daiwa Securities Group In December 2009, we terminated our Daiwa Securities SMBC joint business with Daiwa Securities Group Inc. We sold our 40% equity investment in the former Daiwa Securities SMBC to Daiwa Securities Group, which held the remaining 60%. Through the joint business, which lasted ten years, we engaged in the wholesale securities business and provided a variety of financial services to the Bank’s corporate customers. We currently offer many of these services through SMBC Nikko Securities. Upon the termination, we and Daiwa Securities Group agreed that Daiwa Securities SMBC Principal Investments Co. Ltd., which was a wholly owned subsidiary of Daiwa Securities SMBC, will continue as a joint venture between Daiwa Securities Group (which owns 60% of the shares) and the Bank (which owns the remaining 40%). In July 2010, we also terminated our Daiwa SMBC Capital joint business with the Daiwa Securities Group and executed a company split to form SMBC Venture Capital Co., Ltd., which became our consolidated subsidiary, of which we own 40%. Leasing Sumitomo Mitsui Finance and Leasing Sumitomo Mitsui Finance and Leasing, one of the major leasing companies in Japan, provides a variety of leasing services including equipment lease, operating lease, leveraged lease, and aircraft operating lease. In 2007, Sumitomo Mitsui Finance and Leasing was formed as a result of the merger of SMBC Leasing and Sumisho Lease. We have a 60% equity interest in Sumitomo Mitsui Finance and Leasing, while the remaining 40% is held by Sumitomo Corporation, a non-affiliate. In November 2010, Sumitomo Mitsui Finance and Leasing established SFI Leasing Company, Limited, a joint business with Sony Corporation, in order to further develop our leasing and rental business. On June 1, 2012, the Bank, Sumitomo Mitsui Finance and Leasing and Sumitomo Corporation acquired the aircraft leasing business of The Royal Bank of Scotland Group plc, and commenced its operation as SMBC Aviation Capital. Together with an existing aircraft leasing unit, we and Sumitomo Corporation intend to further expand and develop the aircraft leasing business in Asia and other emerging markets. In addition to the above companies, our U.S. subsidiary SMBC Leasing and Finance, Inc. engages in the leasing business, and our associate Sumitomo Mitsui Auto Service Company, Limited engages in the auto leasing business. Credit Card Sumitomo Mitsui Card Sumitomo Mitsui Card is a leading company in Japan’s credit card industry, having introduced the Visa brand into the Japanese market. Sumitomo Mitsui Card conducts a comprehensive credit card business with a strong brand, and offers a variety of settlement and finance services to meet diverse customer needs. We, Sumitomo Mitsui Card, the Bank and NTT DoCoMo, Inc. formed a strategic business and capital alliance in credit payment service. We have 66% equity interest in Sumitomo Mitsui Card, while the remaining 34% is held by NTT DoCoMo. Pursuant to the alliance, Sumitomo Mitsui Card offers a credit payment service using NTT DoCoMo’s mobile phones equipped with contactless IC chips.
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Table of ContentsIn addition, Sumitomo Mitsui Card issues a variety of affiliated credit cards in cooperation with partners including, but not limited to, railway companies, airline companies, department stores, and retailers, to satisfy both these partners’ and cardholders’ needs. Sumitomo Mitsui Card also provides services for customers such as travelers and retailers both in Japan and China, in alliance with China UnionPay Co., Ltd., a bankcard association established in the People’s Republic of China. Cedyna Cedyna conducts credit card, installment (such as shopping credit and automobile loan), and solution (such as collection outsourcing and factoring) businesses. In April 2009, Central Finance and QUOQ merged into OMC Card, creating Cedyna. Cedyna became our subsidiary after SMFG Card & Credit subscribed to Cedyna’s third-party share allotment in May 2010. Subsequently, in May 2011, Cedyna became our wholly owned subsidiary when SMFG Card & Credit completed a share exchange to acquire the remaining outstanding shares of Cedyna. On March 31, 2012, Cedyna made SMBC Finance Service Co., Ltd. a wholly owned subsidiary. SMBC Finance Service, which had been a subsidiary of the Bank before the reorganization, provides collection outsourcing services and has a strong customer base and internet settlement know-how. Cedyna will transfer its own solution business to SMBC Finance Service in order to strengthen its competitive edge by taking advantage of scale and promoting streamlining. Others In addition to the above companies, our subsidiary Sakura Card Co., Ltd. and our associate Pocket Card Co., Ltd. also engage in the credit card business. Other Major Group Companies and Alliances The Japan Research Institute The Japan Research Institute, Limited is our wholly owned subsidiary that provides financial consultation services on management reform, IT, the planning and development of strategic information systems and outsourcing. It also conducts diverse activities including domestic and international economic research and analysis, policy recommendations and business incubation. In 2009, The Japan Research Institute sold 50% of the shares in JSOL Corporation to NTT Data Corporation, which resulted in JSOL becoming our associate. Prior to the sale, JSOL had been a wholly owned subsidiary of The Japan Research Institute. JSOL offers information technology solutions to customers in the general industrial, financial and public sectors. SMBC Consumer Finance SMBC Consumer Finance, which changed its trade name from Promise on July 1, 2012, is a core entity in our consumer finance business. It provides consumer loans that consist mainly of unsecured loans to individuals, and conducts other business including loan guarantee business. SMBC Consumer Finance guarantees certain consumer loans made by the Bank. We decided to make SMBC Consumer Finance our wholly owned subsidiary in order to reinforce its consumer finance business, to enhance our earnings generation capacity, and to better achieve the expansion of our consumer finance business centered on SMBC Consumer Finance. In December 2011, the Bank made SMBC Consumer Finance its consolidated subsidiary with the completion of a tender offer. Following the tender offer,
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Table of Contentswe subscribed for a third-party allotment of newly issued shares of SMBC Consumer Finance’s common stock. On April 1, 2012, SMBC Consumer Finance became our wholly owned subsidiary upon the completion of a share exchange of shares of our common stock for SMBC Consumer Finance’s common stock, including the shares which the Bank owned. ORIX Credit ORIX Credit offers a wide range of card loan products, focusing on a card loan with a low interest rate and large credit line, and has expanded its business operation by gaining as customers high-income individuals. In July 2009, the Bank acquired a 51% interest in ORIX Credit as part of a collaborative initiative with ORIX, and ORIX Credit became a consolidated subsidiary of the Bank. In March 2011, ORIX Credit entered into a business alliance agreement with SMBC Consumer Finance regarding loan guarantees. On June 29, 2012, the Bank transferred all of its shares of ORIX Credit to ORIX and, as a result, ORIX Credit is no longer our subsidiary. Alliance with Barclays Following an agreement in 2008 between Barclays and the Bank to explore joint business development opportunities, the Bank acquired newly issued shares of Barclays common stock for approximately £500 million. In April 2010, Barclays, the Bank and SMBC Nikko Securities established a division in SMBC Nikko Securities to provide wealth management services to high-net-worth individuals in Japan. In May 2010, the Bank entered into a business alliance agreement with Absa Bank Limited, a group company of Barclays, regarding collaboration on services to Japanese companies in South Africa and other African countries. We have intensified our management-level communications with Barclays regarding, for example, the effects of strengthened regulation of the global banking industry. The Bank believes these initiatives will yield mutual benefits and will facilitate business expansion for us in targeted growth business areas, both foreign and domestic. Credit Loss Protection Agreement with Goldman Sachs To expand its overseas portfolio and revenue, the Bank entered into agreements with Goldman Sachs in 2003 to provide credit protection to Goldman Sachs’ extension of credit to their investment grade clients in exchange for receiving a proportion of the fees and interest income from the borrowers. In connection with the agreements, Goldman Sachs established certain wholly owned subsidiaries (the “William Street Entities”) that might make credit commitments and extensions. Goldman Sachs entered into credit loss protection arrangements with the Bank in order to hedge in part the credit risk to its investment in the William Street Entities. The Bank, through its Cayman Islands branch, would issue letters of credit in exchange for fees equal to a portion of the fees and interest to be paid by the borrowers to the William Street Entities. The first letter of credit (“FLC”), was issued in 2003 in a maximum available amount of $1 billion, and is available over a 20-year period, subject to early termination or extension. Also, from time to time over a 20-year period, subject to early termination or extension and other conditions, upon the request of Goldman Sachs, the Bank has issued letters of credit and may issue one or more additional letters of credit (each a second letter of credit (“SLC Series”) exposing the Bank to risk rated BBB/Baa2 or higher in an aggregate maximum available amount of $1.125 billion). Goldman Sachs may draw on the letters of credit in the event that Goldman Sachs realizes certain losses (“Specified Losses”), with respect to loan commitments or loans extended thereunder that Goldman Sachs has entered into with specified borrowers approved by the Bank and Goldman Sachs. Under the FLC, Goldman Sachs is entitled to draw from time to time amounts equal to approximately 95% of Specified Losses, up to an aggregate stated amount of $1 billion. Under the SLC Series, Goldman Sachs is entitled, subject to certain conditions, to draw from time to time amounts equal to approximately 70% of Specified Losses above specified loss thresholds, up to an aggregate stated amount of $1.125 billion. Goldman Sachs has made a small number of draw downs under the FLC in accordance with its terms.
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Table of ContentsIn connection with these credit arrangements, the Bank pays Goldman Sachs an administration fee based on the aggregate amount of commitments covered by the FLC. The credit loss protection arrangements contain a number of provisions that give the Bank some control over the determination of borrowers to which it has potential exposure under the FLC and any SLC Series:
The Bank, through a separate bankruptcy-remote Cayman Islands subsidiary, has collateralized the obligations on the FLC and a portion of the SLC Series by buying $1.330 billion of Goldman Sachs demand notes and pledging those demand notes to Goldman Sachs. If Goldman Sachs activates an SLC Series that is not collateralized, the Bank through its Cayman Islands subsidiary will be required to purchase and pledge additional Goldman Sachs demand notes with a principal amount equal to the stated amount of that SLC Series. Subject to certain conditions, the Bank has the right to substitute as collateral high quality liquid securities for the Goldman Sachs demand notes. These arrangements are designed to collateralize the Bank’s obligations in the event the Bank’s Cayman Island branch fails to perform on the FLC or any SLC Series, including as a result of our insolvency or the insolvency of the Bank or the Bank’s Cayman Island branch. If Goldman Sachs’ credit rating, as determined by either of the two major credit rating agencies, falls below investment grade, Goldman Sachs is obligated to provide collateral to the Bank to support Goldman Sachs’ obligations under the Goldman Sachs demand notes. After an initial 15-year period under the letters of credit, the Bank and Goldman Sachs will negotiate in good faith to extend the terms of the letter of credit arrangements for one additional five-year term. Before the expiration of the initial 20-year term, in certain circumstances, the letter of credit arrangements with the Bank may be terminated by the Bank or Goldman Sachs, in which event Goldman Sachs would be obligated to prepay any outstanding demand notes. In circumstances related primarily to the creditworthiness of the Bank or a breach of its representations or covenants, Goldman Sachs may draw on the letters of credit for early termination amounts of up to the remaining undrawn or available amount on the letters of credit. In connection with draws on the letters of credit of early termination amounts, Goldman Sachs would have to prepay any outstanding demand notes. Goldman Sachs also would be obligated to pay the Bank on the originally scheduled expiration date of the letter of credit arrangements an amount equal to the early termination amounts minus the losses that would have been reimbursed under the letters of credit had they not terminated early.
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Table of ContentsAt the time the Bank entered into the above credit protection agreements, SMFG issued Type 4 preferred stock amounting to ¥150.3 billion to Goldman Sachs and SMFG and the Bank entered into a business cooperation agreement with Goldman Sachs. However all the Type 4 preferred stock has been converted to common stock and the business cooperation agreement has expired, except for certain rights which will expire in January 2014. Management Policies We aim to be a globally competitive and trusted financial services group by maximizing our strength of Spirit of Innovation, Speed and Solution & Execution. We launched a medium-term management plan in May 2011 for the three years from the fiscal year ended March 31, 2012 to the fiscal year ending March 31, 2014, with the two management objectives as follows:
The following four financial objectives and targets were set with the aim of improving and seeking a balance between financial soundness, profitability and growth. Financial Soundness.
Profitability.
Growth.
Our basic policy for the fiscal year ending March 31, 2013 is as follows: “Move forward steadily towards the targets of the medium-term management plan, capturing opportunities with proactive ideas and actions.” We also intend to continue to implement initiatives for the two strategies—(1) strengthening initiatives in strategic business areas and (2) establishing a solid financial base and corporate infrastructure—of the medium-term management plan. (1) Strengthen initiatives in strategic business areas Financial consulting for retail customers. We intend to continue to make efforts to improve our financial consulting capabilities for retail customers, whose needs are diversifying, through initiatives including an expansion of the product line-up in the securities intermediary business and a reinforcement of insurance business at the Bank. At the same time, we intend to strengthen our client base by promoting collaboration between the Bank’s Middle Market Banking Unit and Consumer Banking Unit, and cross-selling on a Group-wide basis. In addition, we plan to offer products and services addressing individuals’ important life events. We also plan to enhance transaction services and our consumer finance business for retail customers on a Group-wide basis by consolidating the management function of Group companies engaged in these businesses into Consumer Finance & Transaction Business Department.
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Table of ContentsTailor-made solutions for corporate clients. We plan to strengthen responsiveness to customers by reorganizing our marketing framework and optimizing staff allocation. Specifically, we plan to reinforce our lending business and our solution providing capabilities in order to more effectively accommodate diversified and sophisticated financing needs of clients from the planning stage. Commercial banking in emerging markets, especially Asia. We intend to accommodate Japanese clients’ needs, including supporting their international business development, more effectively and in a more integrated manner, and reinforce our growing businesses, including infrastructure finance and trade finance, by expanding our global network, promoting collaboration between domestic and overseas offices and between business units, and strengthening marketing functions associated with investment banking business in Asia. In addition, we plan to secure stable foreign currency funding sources to accommodate an increase of overseas assets. Broker-dealer services and investment banking. We plan to reinforce SMBC Nikko Securities, the principal driver of our securities business, by further promoting collaboration with the Bank and enhancing wholesale securities business capabilities for cross-border M&A and other advisory services. Non-asset business (payment and settlement services and asset management). We aim to accommodate the transaction services needs and accompanying financing needs of corporate clients the world over by flexibly and quickly offering products and services in a more integrated manner. To this end, we intend to leverage the functions of the newly established Transaction Business Planning Department, which devises long-term, integrated transaction services business strategies for our Group and manages settlement risk, and the Transaction Business Division, which promotes transaction services businesses for corporate clients. Regarding our asset management business, we aim to reinforce collaboration within our Group and with overseas asset management companies. (2) Establish a solid financial base and corporate infrastructure In order to strengthen our corporate infrastructure to support sustainable development of our international business, we plan to upgrade our risk management system, develop human resources with international business capabilities and promote national staff. We also aim to upgrade our Group-wide management capabilities by diversifying and enhancing our business portfolio through rebalancing while reinforcing strategic business areas, and pursuing operational efficiency through business process re-engineering. Regarding compliance, we intend to further reinforce our compliance system to address the changing regulatory environment and to more effectively meet local laws and regulations in view of the Group-wide development of our international business. Through these initiatives, we aim to achieve steady results, and further increase the value for our clients and shareholders, financial markets, and society.
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Table of ContentsRevenues by Region The following table sets forth the percentage of our total operating income under IFRS for the fiscal years ended March 31, 2012, 2011 and 2010, based on the total operating income of our offices in the indicated regions. For each of the periods presented, we earned most of our total operating income in Japan, where we compete with other major Japanese banking groups and financial service providers. We earn the remainder in the Americas, Europe and Middle East, and Asia and Oceania, where we mainly compete with global financial institutions.
Seasonality Our business is not materially affected by seasonality. Sources and Availability of Raw Materials We are not reliant on any particular source of raw materials. Marketing Channels Please see “Item 4.B. Business Overview—Description of Operations and Principal Activities” for a discussion of our marketing channels. Regulation Our businesses are subject to extensive regulation, including the effects of changes in the laws, regulations, policies, voluntary codes of practice and interpretations in Japan, and the other jurisdictions in which we operate. On the other hand, deregulation of banking activities in Japan, and more generally of the Japanese financial system, has proceeded. This deregulation is altering two structural features of Japan’s financial system: (1) the separation of banking and securities businesses and (2) distinctions among the permissible activities of Japan’s two principal types of private banking institutions: ordinary banks (futsu-ginko; including both city banks, of which the Bank is one, and regional banks) and trust banks. We also face competition from some government entities, including Japan Post Bank Co., Ltd., one of the world’s largest deposit-taking financial institutions. The Government of Japan has begun to privatize or eliminate several government institutions, in connection with which Japan Post Holdings Co., Ltd., in 2007 became a joint stock corporation, holding shares of four operating companies. Privatization of Japan Post’s banking and insurance subsidiaries, which was originally planned to be completed by 2017, was suspended in December 2009. In April 2012, a law was enacted to abolish the deadline of the privatization of Japan Post’s banking and insurance subsidiaries. The former Securities and Exchange Act separated the commercial banking business from the securities business in Japan. However, the Act on Arrangement of Relevant Acts for the Financial System Reform and the subsequent amendment to the Banking Act now permit banks with the FSA approval to establish or otherwise own domestic and overseas subsidiaries to engage in securities businesses. Since 2004, banks have been
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Table of Contentspermitted to engage in securities intermediation, and more recent amendments have permitted banks to solicit customers for securities trades and act as intermediaries with respect to the resulting trades for securities companies. Within the Japanese consumer banking sector, the deregulation of interest rates on yen deposits has enabled banks to offer customers an increasingly attractive and diversified range of new products. We face competition in this sector from the other city and regional banks as well as from Japan Post Bank. Japanese banks have been competing with one another by developing innovative proprietary computer technologies to allow them to deliver basic banking services in a more efficient manner and to create sophisticated new products in response to customer demand. In addition, the deregulation described above has made the Japanese banking industry highly competitive. For example, the deregulation of the separation of banking and securities businesses enabled the integration and restructuring of Japanese financial institutions that resulted in larger and more integrated financial institutions. In international markets, we face competition from other commercial banks and similar financial institutions, particularly major international banks and the leading domestic banks in those financial markets in which we conduct business. Japan Pursuant to the Banking Act, the FSA has the authority in Japan to supervise banks, bank holding companies and banks’ principal shareholders, meaning bank shareholders having 20% (or 15% in some cases) or more of the voting rights of a bank. The Bank of Japan (“BOJ”) also has supervisory authority over banks in Japan based primarily on its contractual agreements and transactions with Japanese banks. Only companies licensed by the Prime Minister are defined as banks under the Banking Act, and licenses may be granted only to a kabushiki kaisha, a joint stock corporation, with paid-up capital of ¥2 billion or more. The Financial Services Agency Scope of Supervision. The Prime Minister has supervisory authority over banks in Japan, which is generally delegated to the FSA, except for matters prescribed by cabinet order. The Minister for Financial Services has the power to direct the FSA. Under the Banking Act, the FSA has supervisory control over banks, bank holding companies and banks’ principal shareholders in Japan, except for matters to which the Prime Minister retains authority. The FSA’s authority includes approving:
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Table of ContentsThe FSA may also instruct a Japanese bank to suspend its business or to remove directors if the bank violates laws, other regulations or their articles of incorporation or commits acts contrary to public policy. The FSA may also direct a Japanese bank in financial difficulties to hold certain property in Japan for the protection of depositors and to take other actions. Under the prompt corrective action (“PCA”) system, the FSA may take corrective actions in the case of capital deterioration of financial institutions. These actions include (1) requiring a financial institution to formulate and implement reform measures, (2) requiring it to reduce its assets or take other specific actions and (3) issuing an order suspending all or part of its business operations. The Ministry of Finance and the FSA have introduced a number of regulatory measures into the banking sector in Japan to secure sound management of banks, as well as measures to increase the transparency of the regulatory process, including the following: Bank Holding Company Regulations. A bank holding company is prohibited from carrying on any business other than management of its subsidiaries and other incidental businesses. A bank holding company may have any of the following as a subsidiary: a bank, a securities company, an insurance company or a foreign subsidiary that engages in the banking, securities or insurance business. In addition, a bank holding company may have as a subsidiary any company that engages in finance-related business, such as a credit card company, a leasing company or an investment advisory company. Certain companies that are designated by ministerial ordinance as those that cultivate new business fields may also become the subsidiary of a bank holding company. Single Customer Credit Limit. The Banking Act restricts the aggregate amount of loans, guarantees and capital investments to any single customer in order to avoid excessive concentration of credit risks and promote fair and extensive use of bank credit. An ordinary bank’s aggregate exposure to any single customer is limited by the Banking Act and the related cabinet order. The limit is 40% (or 25% if the customer is a principal shareholder of the bank) of an ordinary bank’s total qualifying capital based on aggregate exposure to any single customer including certain of the customer’s affiliates, or 25% (or 15% if the customer is a principal shareholder of the bank) of the bank’s total qualifying capital based on aggregate exposures to any single customer not including the customer’s affiliates. The same restriction applies to a bank group (the bank, its subsidiaries and certain affiliates) on a consolidated basis maximum permitted aggregate exposure by a bank group to a single customer is 25% (or 15% if the customer is a principal shareholder of the bank), and to a customer including certain of the customer’s affiliates is 40% (or 25% if the customer is a principal shareholder of the bank), of the total qualifying capital of the group companies. Disclosure. Under the Banking Act, banks and bank holding companies must disclose their non- and under-performing loans (consolidated and nonconsolidated) as risk-monitored loans. Risk-monitored loans are classified into four categories: (1) bankrupt loans, (2) non-accrual loans, (3) past due loans (three months or more) and (4) restructured loans. Banks and bank holding companies are required to submit annual reports to the FSA on their business including the amount of risk-monitored loans. Banks and bank holding companies must disclose their financial statements on an annual basis. The financial statements consist of the balance sheet and income statement, and explanatory documents regarding business and asset conditions, each prepared under the Banking Act both on a nonconsolidated and consolidated basis. Independent of the Banking Act disclosure regulations, the Act Concerning Emergency Measures for the Revitalization of Financial Functions requires banks to disclose their loans and their other problem assets. Under this law, assets are classified into four categories: (1) bankrupt and quasi-bankrupt assets, (2) doubtful assets, (3) substandard assets and (4) normal assets. Generally, bankrupt and quasi-bankrupt assets correspond to the total of bankrupt loans and the lower tier of the non-accrual loans (the borrowers of which are effectively bankrupt) under the Banking Act disclosure. Doubtful assets generally correspond to the higher tier portion of the non-accrual loans (the borrowers of which are not, but have the potential to become, bankrupt). The substandard loans generally correspond to the total of the restructured loans and past due loans (three months or more). Bankrupt and quasi-bankrupt assets and doubtful assets also include non-loan assets, for example, securities lending, foreign exchange, accrued interest, advanced payments and customers’ liabilities for acceptances and guarantees.
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Table of ContentsNet Deferred Tax Assets. Under FSA guidelines, the amount of net deferred tax assets that can be recorded without diminishing the Tier I capital of major Japanese banks and their holding companies (including us and the Bank) is limited to 20% of the level of their Tier I capital. Reserves for Loan Losses. Based on the Accounting Standards for Banks issued by the Japanese Bankers Association, the Bank, for statutory purposes, establishes three categories of reserves: a general reserve, a specific reserve and a reserve for specific overseas loan losses. The general reserve is provided based on the historical loan-loss ratio for the total of certain outstanding loans of the Bank at each balance sheet date. For Japanese taxation purposes, the amount credited to the general reserve recognized as an expense is generally treated as a tax-deductible reserve, if it is not more than the amount based on the Bank’s average loan loss ratio for the previous three fiscal years. The specific reserve is established for specific loans, the repayment of which is considered materially doubtful, in the same amounts as the amount of the expected losses on these loans. The reserve for specific overseas loan losses is for possible losses on loans to certain countries classified as restructuring countries. The self-assessment rule for the credit quality of the assets of financial institutions, including the Bank, as well as the PCA system, require the Bank to establish a reserve for its loan portfolio in an amount the Bank considers adequate at a balance sheet date. The FSA has issued operating guidelines, called the Financial Inspection Manual, on inspection of financial institutions that include credit-risk management and the standards for write-offs and reserves. The Financial Inspection Manual itself does not have the force of law, but the FSA inspection of banks is based on the Financial Inspection Manual. As a result of an inspection, the FSA may exercise its authority over a bank under the Banking Act to suspend or terminate its banking business. Inspection of Banks. The Banking Act authorizes the FSA to inspect banks and bank holding companies in Japan at any time and with any frequency. Such inspections are conducted by officials from the FSA’s Inspection Department. The FSA monitors the financial soundness of banks and the status and performance of their control systems for business activities by evaluating banks’ systems of self-assessment, auditing their accounts and reviewing their compliance with laws and regulations. Bank inspection is performed pursuant to the Financial Inspection Manual, which emphasizes the need for: bank self-assessment rather than assessment based on the advice of the government authority, and risk management by each bank instead of a mere assessment of its assets. In 2005, the FSA announced that it would change its approach in inspections and shift its emphasis from normalizing the NPLs problem to the protection of consumer interests and strengthening the Japanese financial system through private sector initiatives. Under this framework, which took effect in 2007, FSA inspections emphasize dialogue between inspectors and financial institutions and enhanced verification of risk management and compliance systems. The current framework also introduces a financial inspection ratings system, which provides inspection results in the form of graded evaluations intended to offer an incentive for management action as well as an indication of the FSA’s subsequent regulatory stance with respect to the financial institution in terms of, among other things, frequency and scope of inspections. The FSA has also issued non-binding guidelines to clarify its interpretation and enforcement policies of the Banking Act and related regulations. The Ministry of Finance The Ministry of Finance conducts examinations of banks in relation to foreign exchange transactions under the Foreign Exchange and Foreign Trade Act. The Bank of Japan The BOJ is the central bank of Japan and serves as the principal instrument for the execution of Japan’s monetary policy. The BOJ implements monetary policy mainly by adjusting its basic loan rate, open market
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Table of Contentsoperations and imposing deposit reserve requirements. All banks in Japan maintain deposits with the BOJ and rely substantially upon obtaining borrowings from and rediscounting bills with the BOJ. Moreover, all banks in Japan maintain current accounts under agreements with the BOJ pursuant to which the BOJ can conclude a contract with the Bank concerning on-site examinations. BOJ supervision is intended to support the effective execution of monetary policy, while FSA supervision aims to maintain the sound operations of banks in Japan and promote the security of depositors. Through its examinations, the BOJ seeks to identify problems at an early stage and give corrective guidance where necessary. Capital Adequacy Requirements In 1988, the Basel Committee issued the Basel Capital Accord. The Basel Capital Accord, which was endorsed by the G-10 central bank governors, established a risk-weighted capital ratio as the principal measure of capital adequacy. The Basel Capital Accord sets minimum risk-weighted capital ratios for the purpose of maintaining sound management of banks which have international operations. The minimum risk-weighted capital ratio required is 8% on both a consolidated and nonconsolidated basis. Banks and bank holding companies are required to measure and apply capital charges in respect of their market risks in addition to their credit risks. Market risk is defined as the risk of losses in on- and off-balance sheet positions arising from movements in market prices. The risks subject to this requirement are:
In 2004, the Basel Committee issued the amended Basel Capital Accord (“Basel II”), which includes detailed measurement of credit risk, the addition of operational risk, a supervisory review process and market discipline through disclosure. These amendments did not change the minimum risk-weighted capital ratio of 8% applicable to banks with international operations (including the Bank). These rules took effect in Japan in 2007, and since 2008 banks are able to apply the advanced IRB approach for credit risk and the AMA for operational risk. In addition to new methods for risk-weighting and new requirements to measure and establish reserves for operational risk, the new FSA capital adequacy guidelines also required Japanese banks and bank holding companies to expand their disclosure regarding capital ratio data. Banks and bank holding companies must include detailed disclosure in their annual and semiannual Japanese language disclosure reports (disclosure shi). The required disclosure includes detailed information regarding risk-weighting calculations and operational risk measurement calculations underlying capital ratio data. Under the Banking Act and its related regulations, banks and bank holding companies are required to publish their annual disclosure reports within four months of the end of the fiscal year and to publish their semiannual disclosure reports within four months of the end of the interim period. In July 2009, the Basel Committee approved a final package of measures to enhance certain elements of the Basel II framework which includes an increase of the risk weights of resecuritization instruments and revisions of certain trading book rules (referred to as “Basel 2.5”), and the FSA’s capital adequacy guidelines which reflect such framework have been applied in Japan from December 2011. In September 2009, the Group of Central Bank Governors and Heads of Supervision reached an agreement on several key measures to strengthen regulation of the banking sector, and in December 2009 the Basel Committee published a consultative document entitled “Strengthening the resilience of the banking sector” containing proposals on these measures centering on several core areas. The Basel Committee’s proposals focused on raising the quality, consistency and transparency of the regulatory capital base through measures including a requirement that the predominant form of Tier I capital must be common shares and retained earnings; limitations on the use of hybrid instruments with an incentive to redeem; a requirement that regulatory
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Table of Contentsadjustments, including deductions of the amount of net deferred tax assets which rely on the future profitability of a bank, be applied to common equity generally; and a requirement for additional disclosure regarding regulatory capital levels. The Basel Committee’s proposals also cover the following key areas:
In July 2010, the Group of Central Bank Governors and Heads of Supervision reached a broad agreement on the overall design of the Basel Committee’s capital and liquidity reform package. In addition, in August 2010, the Basel Committee issued for consultation a proposal to enhance the loss absorbency function of regulatory capital. In September 2010, the Group of Central Bank Governors and Heads of Supervision announced a substantial strengthening of existing capital requirements. The framework of the proposed reform was endorsed by the G-20 leaders at their Seoul summit in November 2010. These capital reforms will increase the minimum common equity requirement from 2% to 4.5% and require banks to hold a capital conservation buffer of 2.5% to withstand future periods of stress, bringing the total common equity requirement to 7%. The Tier I capital requirement will also be increased from 4% to 6% (together with the above capital conservation buffer, to 8.5%). The total capital requirement will remain at the existing level of 8% but will be increased to 10.5% with the capital conservation buffer. In addition, a countercyclical buffer within a range of 0% to 2.5% of common equity or other fully loss-absorbing capital will be implemented according to national circumstances. The Group of Central Bank Governors and Heads of Supervision also agreed on transitional arrangements for implementing the new standards. Under the transitional arrangements, these new capital requirements will be phased in between January 1, 2013 and January 1, 2019. In December 2010, the Basel Committee published the new Basel III rules text. To reflect changes made by the Basel Committee, the FSA changed its capital adequacy guidelines and the changes will be generally applied from March 31, 2013, which generally reflects the main measures of the minimum capital requirements of the Basel Committee that are scheduled to be phased in starting January 1, 2013. On November 4, 2011, the FSB released its list of 29 banks which are G-SIFIs, and this list included us. Because we have been identified as a G-SIFI, we are subject, among other things, to resolution-related requirements described in the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions.” In particular, the FSB has required the initial group of G-SIFIs, by the end of 2012, to have in place a recovery and resolution plan, including a group-level plan, containing various specified elements, to be subject to regular resolvability assessments. The FSB will revise and update its list of G-SIFIs on an annual basis and G-SIFIs included on the list in November 2014 will be subject to an additional loss absorbency requirement that will be phased in from January 2016 with full implementation by January 2019. If we are identified as a G-SIFI in November 2014, we will be required to maintain 1% to 2.5% additional loss absorption capacity above the Basel III common equity Tier I minimum requirement of 7%, depending upon our systemic importance as determined by the FSB. Furthermore, as a disincentive for banks facing the highest required level of common equity Tier I to “increase materially their global systemic importance in the future,” an additional 1% charge could be applied. Also beginning in November 2014, so long as we are identified as a G-SIFI, we will be subject to stronger supervisory mandates and higher supervisory expectations for risk management functions, data aggregation capabilities, risk governance and internal controls. The substance of this heightened supervision has not yet been fixed, but we anticipate that at a minimum any rules will contain more stringent reporting requirements and impose common frameworks for data aggregation and internal risk management processes on G-SIFIs.
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Table of ContentsOur securities subsidiaries in Japan are also subject to capital adequacy requirements under the FIEA. Under the requirements, securities firms must maintain a minimum capital adequacy ratio of 120% on a nonconsolidated basis and must file periodic reports with the Commissioner of the FSA or the Director-General of the appropriate Local Finance Bureau, and also publicly disclose their capital adequacy ratio on a quarterly basis. Failure to meet the capital adequacy requirements will trigger mandatory regulatory action. For example, a securities firm with a capital adequacy ratio of greater than 120%, but less than 140% will be required to file daily reports with the Commissioner of the FSA or the Director-General of the appropriate Local Finance Bureau. A securities firm with a capital adequacy ratio of less than 120% may be ordered to change its business conduct, place its property in trust or be subject to other supervisory orders, as the relevant authorities deem appropriate. A securities firm with a capital adequacy ratio of less than 100% may be subject to temporary suspension of all or part of its business operations or cancellation of its license to act as a securities broker and dealer. The capital adequacy ratio for securities firms is defined as the ratio of adjusted capital to a quantified total of business risks, which include market risks, counterparty risks and operational risks (e.g., risks in carrying out daily business activities, such as administrative problems with securities transactions and clerical mistakes) quantified in the manner specified by a rule promulgated under the FIEA. Adjusted capital is defined as net worth less illiquid assets, as determined in accordance with Japanese GAAP. Net worth consists mainly of stated capital, additional paid-in capital, retained earnings, reserves for securities transactions, certain allowances for doubtful current accounts, net unrealized gains (losses) in the market value of investment securities, and subordinated debt. Illiquid assets generally include non-current market assets, certain deposits and advances, and prepaid expenses. In May 2010, the FIEA was amended, introducing a minimum capital adequacy requirement on a consolidated basis applicable to securities firms whose total assets exceed ¥1,000 billion. These amendments became effective from April 1, 2011. PCA and Self-Assessment Under the PCA system, the FSA may take corrective actions depending upon the extent of capital deterioration of a financial institution. The PCA system also requires financial institutions to establish self-assessment programs. Financial institutions, including the Bank, are required to analyze their assets giving due consideration to accounting principles and other applicable rules and to classify their assets into categories taking into account the likelihood of repayment and the risk of impairment to the value of the assets. These classifications determine whether an addition to or reduction in reserves or write-offs is necessary. Pursuant to the Japanese Institute of Certified Public Accountants (“JICPA”), guidelines, the outcome of each financial institution’s self-assessment leads to substantially all of a bank’s loans and other claims on customers being analyzed by classifying obligors into five categories: (1) normal borrowers; (2) borrowers requiring caution; (3) potentially bankrupt borrowers; (4) effectively bankrupt borrowers; and (5) bankrupt borrowers. The reserve for possible loan losses is then calculated based on the obligor categories. FSA guidelines require banks to classify their assets not only by the five categories of obligor but also by four categories of quality. The Bank has adopted its own internal guidelines for self-assessment which conform to guidelines currently in effect and comply with the PCA system requirements. Under the PCA system, if the risk-weighted capital ratio of a bank or a bank holding company with international operations becomes less than 8% but not less than 4%, the FSA may require a bank or a bank holding company to submit and implement a capital reform plan. If the risk-weighted capital ratio of a bank with international operations declines to less than 4% but not less than 2%, the FSA may order a bank to (1) submit and implement a plan for improving its capital; (2) prohibit or restrict the payment of dividends to shareholders or bonuses to officers; (3) reduce assets or restrict any increase
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Table of Contentsin assets; (4) prohibit or restrict the acceptance of deposits under terms less advantageous than ordinary terms; (5) reduce the business of some offices; (6) eliminate some offices other than the head office; (7) reduce or prevent the launching of non-banking businesses; or (8) take certain other actions. If the risk-weighted capital ratio of a bank with international operations declines to less than 2% but not less than 0%, the FSA may order a bank to conduct any one of the following: (1) a capital increase; (2) a substantial reduction in its business; (3) a merger; or (4) abolishment of its banking business. If the risk-weighted capital ratio of a bank with international operations declines below 0%, the FSA may order the bank to suspend all or part of its business. If the risk-weighted capital ratio of a bank holding company that holds a bank with international operations declines to levels below 8%, the FSA may take actions similar to the actions the FSA may take with respect to a bank. Prompt Warning System The prompt warning system currently in effect allows the FSA to take precautionary measures to maintain and promote the sound operation of financial institutions before those financial institutions become subject to the PCA system. These measures include requiring a financial institution to reform: (1) profitability, if deemed necessary to improve profitability based upon a fundamental profit index; (2) credit risk management, if deemed necessary to reform management of credit risk based upon the degree of large credit concentration and other circumstances; (3) stability, if deemed necessary to reform management of market and other risks based upon, in particular, the effect of securities price fluctuations; and (4) cash flow management, if deemed necessary to reform management of liquidity risks based upon deposit trends and level of reserve for liquidity. Deposit Insurance System The Deposit Insurance Act was enacted to protect depositors when financial institutions fail to meet their obligations. The DIC implements the law and is supervised by the Prime Minister and the Minister of Finance. Subject to limited exceptions, the Prime Minister’s authority is delegated to the FSA Commissioner. Since April 2010, the DIC receives annual insurance premiums from member financial institutions equivalent to 0.107% of deposits that bear no interest, are redeemable upon demand and are used by depositors primarily for payment and settlement purposes, and premiums equivalent to 0.082% of other deposits. Beginning from April 2012, if there is no member financial institutions fail during the fiscal year, a premium rate of 0.089% for deposits primarily for payment and settlement purposes, and a premium rate of 0.068% for other deposits, will be applied and the amount equivalent to 0.018% of deposits primarily for payment and settlement purposes, and 0.014% of other deposits, without interest, will be reimbursed to the member institutions. The same formula will apply for the fiscal years beginning from April 2013 and 2014. Premiums held by the DIC may be either deposited at financial institutions or used to purchase marketable securities. The insurance money may be paid out to depositors in case of a suspension of repayments of deposits, banking license revocation, dissolution or bankruptcy of a bank. Payouts are generally limited to a maximum of ¥10 million of principal amount together with any interest accrued with respect to each depositor. Only non-interest-bearing deposits that are redeemable upon demand and used by depositors primarily for payment and settlement functions are protected in full. City banks (including the Bank), regional banks (including member banks of the second association of regional banks), trust banks, credit associations, credit cooperatives, labor banks and Japan Post Bank participate in the deposit insurance system on a compulsory basis.
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Table of ContentsResolutions of Failed Financial Institutions The Deposit Insurance Act currently provides a permanent system for resolving failed financial institutions. The basic method for resolving a failed financial institution under the Deposit Insurance Act is cessation of the business by paying insurance money to depositors up to the principal amount of ¥10 million plus accrued interest per depositor, or pay-off or transfer of the business to another financial institution, with financial assistance provided within the cost of pay-off. Under the Deposit Insurance Act, transfer of business is regarded as the primary method. In order to effect a prompt transfer of business, the following framework has been established:
Where it is anticipated that the failure of a financial institution may cause an extremely grave problem in maintaining the financial order in Japan or the region where the financial institution is operating, the following exceptional measures may be taken after consulting with the Conference for Financial Crisis Countermeasures:
In order to fund the above-mentioned activities, the DIC may borrow from financial institutions or issue bonds which may be guaranteed by the government. The Resolution and Collection Corporation The Resolution and Collection Corporation ( “RCC”), a wholly owned subsidiary of the DIC, is permitted to purchase underperforming loan receivables from failed financial institutions. The DIC guarantees financing for the RCC’s business and compensates the RCC for losses that it incurs. Special Measures Act Concerning Facilitation of Reorganization by Financial Institutions, Etc. Under the Special Measures Act Concerning Facilitation of Reorganization by Financial Institutions, Etc.: (1) for one year after the merger or transfer of the entire business of a financial institution, the maximum amount to be covered by the deposit insurance will be ¥10 million multiplied by the number of parties to the merger or business transfer; and (2) the procedures are simplified to a certain extent in connection with the transfer of an entire business or a merger with another financial institution by a financial institution that is made in accordance with a management base-strengthening plan that has been approved by the government.
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Table of ContentsCapital Injection by the Government In response to the 2008 financial turmoil, amendments to the Special Measures Act for Strengthening Financial Functions, the Special Measures Act Concerning Facilitation of Reorganization by Financial Institutions, and other related legislation were enacted by the Diet in 2008 in order to authorize capital contributions to financial institutions by the Government of Japan. The amendments include: (1) extension to March 31, 2012 of a deadline for financial institutions to apply to the government for capital contributions; (2) other revisions of the government requirements associated with capital contributions intended to facilitate the financing of SMEs; and (3) amendments which permit the government to make capital contributions to credit cooperatives, credit unions and other types of cooperative financial institutions. In June 2011, in response to the Great East Japan Earthquake, amendments to the Special Measures Act for Strengthening Financial Functions were enacted and extended the deadline described above to March 31, 2017. The amendments also include special exceptions for financial institutions affected by the Great East Japan Earthquake that need capital enhancement for the smooth extension of loans in their main business area, which are not applicable to any of the financial institutions within the Group. Restriction on Aggregate Shareholdings by a Bank The Act Concerning Restriction on Shareholdings by Banks requires Japanese banks and their qualified subsidiaries to limit the aggregate market value (excluding unrealized gains, if any) of their equity securities holdings to an amount equal to 100% of their consolidated Tier I capital, with adjustments, in order to reduce exposure to stock price fluctuations. Treasury shares, shares issued by subsidiaries, shares not listed on any stock exchange or not registered with any OTC market, shares held as trust assets, and shares acquired through debt-for-equity swaps in restructuring transactions are excluded from this limitation. Banks’ Shareholdings Purchase Corporation In March 2009, legislation that was enacted and became effective restarted share purchases by the Banks’ Shareholdings Purchase Corporation of listed shares from banks and certain other financial institutions under certain conditions. These shares purchases are intended to facilitate the disposition of shares of listed stocks held by banks while preventing adverse effects caused by sales of large amounts of shares in a short period of time. Shareholding Restrictions Applicable to a Bank Holding Company and a Bank The provision of the Act on Prohibition of Private Monopolization and Maintenance of Fair Trade which prohibits banks from holding more than 5% of the voting rights of non-financial companies in Japan does not apply to bank holding companies. However, the Banking Act generally prohibits a bank holding company and its subsidiaries, on an aggregated basis, from holding more than 15% of the voting rights of certain types of companies which are not permitted to become subsidiaries of bank holding companies. Also, the Banking Act generally prohibits a bank and its subsidiaries, on an aggregated basis, from holding more than 5% of the voting rights of certain types of companies which are not permitted to become subsidiaries of banks. Examination and Reporting Applicable to Shareholders of a Bank The FSA may request the submission of reports or other materials from a bank and/or its bank holding company, or inspect the bank and/or the bank holding company, if necessary, in order to secure the sound and appropriate operation of the business of a bank. Under the Banking Act, a person who desires to hold 20% (in some exceptional cases, 15%) or more of the voting rights of a bank is required to obtain advance approval of the FSA Commissioner. In addition, the FSA may request the submission of reports or materials from, or may conduct an inspection of, any principal shareholder who holds 20% (in some exceptional cases, 15%) or more of the voting rights of a bank if the FSA deems the action necessary in order to secure the sound and appropriate operation of the business of the bank. Under limited circumstances, the FSA may order the principal shareholder to take such measures as the FSA deems necessary.
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Table of ContentsFurthermore, any person who becomes a holder of more than 5% of the voting rights of a bank holding company or a bank must report the ownership of the voting rights to the Director General of the relevant local finance bureau within five business days. This requirement is separate from the significant shareholdings report required under the FIEA. In addition, a similar report must be made in respect of any subsequent change of 1% or more in any previously reported holding or in respect of any change in material matters set out in reports previously filed, with some exceptions. The Act Concerning Temporary Measures to Facilitate Financing for SMEs, etc. The Act Concerning Temporary Measures to Facilitate Financing for SMEs, etc., became effective in December 2009 and requires financial institutions to, among other things, endeavor to reduce their customers’ burden of loan payments by employing such methods as term modification at the request of eligible borrowers, including SMEs and individual housing loan borrowers. The legislation also requires financial institutions to internally establish a system to implement the requirements of the legislation and periodically make disclosures regarding, and report to the relevant authority the status of, implementation. Following the enactment of the legislation, the FSA altered its approach toward inspections and shifted its emphasis to facilitation of finance while monitoring risks appropriately. These measures were originally scheduled to remain effective until March 2011, but the effective period was extended until March 2013. Protection of Personal Information The Act on Protection of Personal Information and related rules, regulations and guidelines impose requirements on businesses that use databases containing personal information, including appropriate custody of personal information and restrictions on information sharing with third parties. Act on Sales, Etc. of Financial Products Due to deregulatory measures in the banking and other financial services industries, more financial products, including highly structured and other complicated products, may now be marketed to a broad base of customers. The Act on Sales, Etc. of Financial Products was enacted to better protect customers from incurring unexpected losses as a result of purchasing these financial products. Under this law, sellers of financial products have a duty to their potential customers to explain important matters (i.e., the nature and magnitude of risk involved) regarding the financial products that they sell. If a seller fails to comply with the duty, the loss in value of the purchased investment product due to the failure to explain is refutably presumed to be the amount of the customer’s loss. An amendment to this law, together with other related laws including the FIEA, became effective in September 2007. The amended law enlarges the scope of the duty of financial services providers to inform customers of important matters related to the financial products that they offer. Act Concerning Protection of Depositors and Relief for Victims of Certain Types of Fraud The Act Concerning Protection of Depositors from Illegal Withdrawals Made by Forged or Stolen Cards requires financial institutions to establish internal systems to prevent illegal withdrawals of deposits made using forged or stolen bank cards. The law also requires financial institutions to compensate depositors for any amount illegally withdrawn using forged or stolen bankcards, subject to certain conditions. The Act Concerning Payment of Dividends for Relief of Damages from Funds in Account used in connection with Crimes (Act No. 133 of 2007) requires that financial institutions take appropriate measures against various crimes including the closing of accounts used in connection with fraud and other crimes. The law also requires financial institutions to make, in accordance with specified procedures, payments from funds collected from the closed accounts to victims of certain crimes.
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Table of ContentsAct on Prevention of Transfer of Criminal Proceeds Under the Act on Prevention of Transfer of Criminal Proceeds (Act No. 22 of 2007), which addresses money laundering and terrorism concerns, financial institutions and certain other entities, such as credit card companies, are required to perform customer identification, submit suspicious transaction reports and keep records of their transactions. FIEA The Financial Instruments and Exchange Act of Japan (“FIEA”) regulates the securities industry and most aspects of securities transactions in Japan, including public offerings, private placements and secondary trading of securities, ongoing disclosure by securities issuers, tender offers for securities, organization and operation of securities exchanges and self-regulatory organizations and registration of securities companies. The Prime Minister has the authority to regulate the securities industry and securities companies, which authority is delegated to the FSA Commissioner under the FIEA. The Securities and Exchange Surveillance Commission, an external agency of the FSA, is independent from the Agency’s other bureaus and is vested with authority to conduct day-to-day monitoring of the securities markets and to investigate irregular activities that hinder fair trading of securities, including inspection of securities companies as well as banks in connection with their securities business. Furthermore, the FSA Commissioner delegates certain authority to the Director General of the Local Finance Bureau to inspect local securities companies and their branches. A violation of applicable laws and regulations may result in various administrative sanctions, including revocation of registration or authorization, suspension of business or an order to discharge any Director or Executive Officer who has failed to comply with applicable laws and regulations. Securities companies are also subject to the rules and regulations of the Japanese stock exchanges and the Japan Securities Dealers Association, a self-regulatory organization of securities companies. The FIEA replaced the Securities and Exchange Act in order to broaden and strengthen investor protection and to reduce trading costs through deregulation and the easing or elimination of certain regulatory restrictions. The regime under the FIEA includes, among other measures, (1) the development of comprehensive and cross-sectoral regulations covering a wide range of financial instruments; (2) the enhancement of corporate disclosure, requiring listed companies to file quarterly reports, audited internal control reports assessing the effectiveness of internal control structures for financial reporting, and confirmation of the content of annual reports; (3) the expansion of the duties of financial institutions to provide customers with detailed disclosure regarding the financial products that they offer and other measures to protect investors; and (4) the relaxation of regulations through flexible application depending on the type of investor (professional or general public). Deregulation of the Securities Business by a Bank Due to gradual deregulation, the Securities and Exchange Act allowed banks to underwrite and deal in Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, commercial paper and certain bonds issued by special purpose companies; to sell beneficiary certificates of investment trusts and securities issued by an investment company; and to engage in listed or OTC securities derivatives transactions as well as in the securities intermediary business, each subject to registration with the FSA. In addition, amendments to the FIEA and the Banking Act, that became effective on June 1, 2009, abolished restrictions on directors and officers holding concurrent offices in banks, securities companies and insurance companies, and introduced a system to manage conflicts of interest between banks, securities companies and insurance companies. The amendments provide for revised firewalls between banks, securities companies and insurance companies; and the development of a system to manage conflicts of interest between banks, securities companies and insurance companies. The amendment relating to firewalls abolished the ban on certain officers and employees from holding concurrent posts in banks, securities companies and insurance companies, and relaxed restrictions on the transfer of non-public customer information. On the other hand, the amendment relating to conflicts of interest requires those financial institutions, including banks, to implement proper information management procedures and to develop appropriate internal systems to prevent customer interests
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Table of Contentsfrom being unfairly harmed through trading by a financial institution or by other companies within its group. For example, a financial institution may be required to create information barriers between departments and monitor how it executes transactions with customers. Deregulation of Insurance Products Deregulation in the financial services industry has gradually permitted banks in Japan to offer a variety of insurance products including pension-type insurance. Currently, banks in Japan may offer a full range of insurance products as an agent. Regulation of the Consumer Finance Business In order to resolve the problems of heavily indebted borrowers and to effect proper regulation of the consumer finance business, in June 2010, maximum legal interest rates were reduced to levels prescribed by the Interest Rate Restriction Act, ranging from 15% to 20%, and gray zone interest, which is interest on loans in excess of rates prescribed by the Interest Rate Restriction Act up to the 29.2% maximum rate permitted under the Contributions Act, was abolished. Judicial decisions have strictly interpreted the conditions under which consumer finance companies may retain gray zone interest. As a result, claims for refunds of gray zone interest increased substantially. Amendments to the Money Lending Business Act provide an additional upper limit on aggregate borrowings by an individual from all moneylenders over which moneylenders may not extend further loans, as well as stricter regulation and supervision of moneylender activities. Installment Sales Act In order to ensure the fairness of transactions with respect to installment and other sales, prevent damage to consumers and manage credit card numbers, the Installment Sales Act imposes requirements on those who conduct installment sales businesses. In June 2008, revisions to the Installment Sales Act were enacted, most of which became effective in December 2009. The revisions impose more stringent and expanded requirements for credit card companies, including, among other things: (1) wider coverage of installment sales under the regulations; (2) measures to prevent inappropriate extensions of credit for certain credit transactions; (3) measures to prevent excessive lending for certain credit transactions that include requirements to investigate the payment ability of consumers by use of designated credit information organizations and prohibition of execution of credit agreements that exceed the payment ability of consumers; and (4) measures to protect certain information, such as credit numbers. United States As a result of its operations in the United States, the Bank and SMFG are subject to extensive federal and state banking and securities supervision and regulation. The Bank engages in U.S. banking activities directly through its branches in Los Angeles, San Francisco and New York and through its representative office in Houston. The Bank also controls a U.S. banking subsidiary, Manufacturers Bank, and a U.S. broker-dealer subsidiary, SMBC Nikko Securities America, Inc. The Bank and SMFG are qualifying foreign banking organizations under the U.S. International Banking Act of 1978 as amended (“International Banking Act”), and as such are subject to regulation as bank holding companies under the U.S. Bank Holding Company Act of 1956, as amended (“Bank Holding Company Act”). Additionally, the Bank and SMFG are bank holding companies by virtue of their ownership of Manufacturers Bank. As a result, the Bank, SMFG and their U.S. operations are subject to regulation, supervision and examination by the Federal Reserve Board as Manufacturers Bank’s U.S. “umbrella supervisor.” Manufacturers Bank is a California state-chartered bank, which is not a member of the Federal Reserve System. As a state non-member bank, the deposits of which are insured by the Federal Deposit Insurance Corporation (“FDIC”), Manufacturers Bank is subject to regulation, supervision and examination by the FDIC and the California Department of Financial Institutions.
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Table of ContentsThe Bank’s New York branch is supervised by the Federal Reserve Bank of New York and the New York Department of Financial Services, but its deposits are not insured (or eligible to be insured) by the FDIC. The Bank’s Los Angeles and San Francisco branches are supervised by the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions, but their deposits are not insured (or eligible to be insured) by the FDIC. The Bank’s representative office in Houston is subject to regulation and examination by the Texas Department of Financial Institutions and the Federal Reserve Bank of Dallas. Restrictions on Activities As described below, federal and state banking laws and regulations restrict the Bank’s and SMFG’s ability to engage, directly or indirectly through subsidiaries, in certain activities in the United States. The Bank and SMFG are required to obtain the prior approval of the Federal Reserve Board before directly or indirectly acquiring the ownership or control of more than 5% of any class of voting shares of U.S. banks, certain other depository institutions and bank or depository institution holding companies. Under the Bank Holding Company Act and Federal Reserve Board regulations, the Bank is required to serve as a source of financial strength to Manufacturers Bank. In addition, the Bank’s U.S. banking operations (including Manufacturers Bank and the Bank’s U.S. branches) are also restricted from engaging in certain “tying” arrangements involving products and services. In addition, the activities of the non-bank subsidiaries of the Bank and SMFG are generally limited to those activities that the Federal Reserve Board has determined to be a proper incident to banking or managing and controlling banks, and the Bank Holding Company Act generally prohibits the Bank and SMFG from acquiring, directly or indirectly, the ownership or control of more than 5% of any class of voting shares of any company engaged in the United States in activities other than banking or activities deemed a proper incident to banking or managing and controlling banks. Federal Reserve Board approval is generally required for the Bank and SMFG to acquire more than 5% of any class of voting shares of a U.S. company engaged in permissible non-banking activities. The Bank’s U.S. branches and Manufacturers Bank are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be made and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of Manufacturers Bank, and to a limited extent, the Bank’s New York and California branches. In addition, under U.S. federal banking laws, state-chartered banks (such as Manufacturers Bank) and state-licensed branches and agencies of foreign banks (such as the Bank’s New York branch) may not, as a general matter, engage as a principal in any type of activity not permissible for their federally chartered or licensed counterparts, unless (i) in the case of state-chartered banks, the FDIC determines that the additional activity would pose no significant risk to the FDIC’s Deposit Insurance Fund and is consistent with sound banking practices and (ii) in the case of state-licensed branches and agencies of foreign banks, the Federal Reserve Board determines that the additional activity is consistent with sound banking practices. United States federal banking laws also subject state branches and agencies of foreign banks to the same single-borrower lending limits that apply to federal branches or agencies, which are substantially similar to the lending limits applicable to national banks. For the Bank’s U.S. branches, these single-borrower lending limits are based on the worldwide capital of the entire foreign bank (i.e., the Bank in the case of the Bank’s New York branch). Under the International Banking Act, the Federal Reserve Board may terminate the activities of any U.S. office of a foreign bank if it determines (i) that the foreign bank is not subject to comprehensive supervision on a consolidated basis in its home country (unless the home country is making demonstrable progress toward establishing such supervision), (ii) that there is reasonable cause to believe that such foreign bank or its affiliate has violated the law or engaged in an unsafe or unsound banking practice in the United States and, as a result of such violation or practice, the continued operation of the U.S. office would be inconsistent with the public interest or with the purposes of federal banking laws, or (iii) for a foreign bank that presents a risk to the stability
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Table of Contentsof the United States financial system, the home country of the foreign bank has not adopted, or made demonstrable progress toward adopting, an appropriate system of financial regulation to mitigate such risk. There are various qualitative and quantitative restrictions on the extent to which SMFG and its non-bank subsidiaries can borrow or otherwise obtain credit from its U.S. bank subsidiary, Manufacturers Bank, or engage in certain other transactions involving that subsidiary. In general, these transactions must be on terms that would ordinarily be offered by Manufacturers Bank to unaffiliated entities, and credit transactions must be secured by designated amounts of specified collateral. In addition, certain transactions, such as certain purchases by Manufacturers Bank from the Bank or its non-bank subsidiaries, are subject to volume limitations. Effective in July 2012, the Dodd-Frank Act (discussed below) subjects credit exposure arising from derivative transactions, securities borrowing and lending transactions, and repurchase/reverse repurchase agreements to these collateral and volume transactions limitations. Dodd-Frank Act The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which was enacted in July, 2010, provides a broad framework for significant regulatory changes across most areas of U.S. financial regulation. The Dodd-Frank Act addresses, among other issues, systemic risk oversight, bank capital standards, the liquidation of failing systemically significant U.S. financial institutions, OTC derivatives, the ability of banking entities to engage in proprietary trading activities and invest in hedge funds and private equity funds (known as the “Volcker Rule”) consumer and investor protection, and securitization. Implementation of the Dodd-Frank Act is taking place through detailed rulemaking over multiple years by various regulators, including the Office of the Comptroller of the Currency, the Federal Reserve Board, the SEC, the FDIC, the Commodity Futures Trading Commission (“CFTC”), the newly created Financial Stability Oversight Council (“Council”) and the newly created Consumer Financial Protection Bureau. Although the final details, impact and timing of certain of the implementing rules remain uncertain, complying with the final rules could result in additional costs, or restrict or otherwise affect the way we conduct our business. The Dodd-Frank Act provides regulators with tools to impose greater capital, leverage and liquidity requirements and other prudential standards, particularly for financial institutions that pose significant systemic risk and bank holding companies with greater than $50 billion in assets. In imposing such heightened prudential standards on non-U.S. banks such as us and the Bank, the Federal Reserve Board is directed to take into account the principle of national treatment and equality of competitive opportunity, and the extent to which the foreign bank holding company is subject to comparable home country standards. The Dodd-Frank Act will also limit the ability of bank holding companies to sponsor or invest in private equity or hedge funds (including an aggregate investment limit of 3% of Tier I capital in funds that are sponsored by the bank holding company) and to engage in certain types of proprietary trading, although certain non-U.S. banking entities (such as the Bank and SMFG) will be able to engage in such activities solely outside the United States. The U.S. agencies responsible for implementing the Volcker Rule proposed implementing rules in October 2011 and January 2012 but have not yet adopted final rules. The Volcker Rule became effective on July 21, 2012, although banking entities will have at least two years from that date to conform activities, investments and relationships in accordance with the Volcker Rule and the rules that are to be adopted by the agencies. Effective in July 2011, the Dodd-Frank Act removed a longstanding prohibition on the payment of interest on demand deposits by Manufacturers Bank and the Bank’s three branches in the United Sates. In addition, the Dodd-Frank Act will require Manufacturers Bank and the Bank’s U.S. branches to include in their lending limits the credit exposures arising from derivative transactions, and repurchase and reverse repurchase agreements with counterparties.
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Table of ContentsFurthermore, the Dodd-Frank Act provides for an extensive framework for the regulation of OTC derivatives, including mandatory clearing, exchange trading and transaction reporting of certain OTC derivatives. Entities that are swap dealers, security-based swap dealers, major swap participants or major security-based swap participants will be required to register with the SEC or the CFTC, or both, and comply with capital, margin, business conduct, recordkeeping and other requirements applicable to such entities. Under the so-called swap “push-out” provisions of the Dodd-Frank Act, the derivatives activities of U.S. banks and U.S. branch offices of foreign banks (such as the Bank’s New York branch) will be restricted, which may necessitate changes to how we conduct our derivatives activities. Regulations that the FDIC or the Consumer Financial Protection Bureau may adopt could affect the nature of the activities that a bank, such as Manufacturers Bank, may conduct, and may impose restrictions and limitations on the conduct of such activities. Furthermore, the Dodd-Frank Act requires the SEC to establish rules requiring issuers with listed securities, which may include foreign private issuers such as us, to establish a “clawback” policy to recoup previously awarded compensation in the event of an accounting restatement. The Dodd-Frank Act also grants the SEC discretionary rule-making authority to impose a new fiduciary standard on brokers, dealers and investment advisers, and expands the extraterritorial jurisdiction of U.S. courts over actions brought by the SEC or the United States with respect to violations of the antifraud provisions in the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. PATRIOT Act The Bank Secrecy Act, as amended by the USA PATRIOT Act of 2001 (“PATRIOT Act”) contains measures to prevent and detect the financing of terrorism and international money laundering by imposing significant compliance and due diligence obligations, creating crimes, providing for penalties and expanding the extraterritorial jurisdiction of the United States. The Bank Secrecy Act, as amended, imposes anti-money laundering compliance obligations on U.S. financial institutions, including the U.S. offices of foreign banks. The passage of the PATRIOT Act and other events have resulted in heightened scrutiny of compliance with the Bank Secrecy Act and anti-money laundering rules by federal and state regulatory and law enforcement authorities. CISADA In July 2010, the U.S. government enacted legislation designed to restrict economic and financial transactions with Iran, i.e., Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010 (“CISADA”), which may lead to the imposition of sanctions against non-U.S. financial institutions, such as us, if they are determined by the Secretary of the Treasury to have facilitated “significant transactions” or provided “significant financial services” for certain Iran-linked financial institutions or the Iranian Revolutionary Guard Corps. NDAA The U.S. government broadened the range of sanctionable transactions to include conducting or facilitating “significant financial transactions” with the Central Bank of Iran or certain other Iranian financial institutions by adopting the National Defense Authorization Act for Fiscal Year 2012 (the “NDAA”), as implemented by Executive Order 13599 of February 5, 2012 and by amending the Iranian Financial Sanctions Regulations on February 27, 2012. These or similar legislative or regulatory developments may further limit our business operations. Specifically, we could lose our ability to maintain correspondent or payable-through accounts with U.S. financial institutions if it were determined that we have engaged in activities targeted by CISADA or the NDAA. The Secretary of State announced on March 20, 2012 that Japan is among a group of countries that has significantly reduced their volume of crude oil purchases from Iran, and that therefore the NDAA sanctions
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Table of Contentswould not apply to Japanese financial institutions for a period of 180 days, which period is renewable based on ongoing reductions in crude oil purchases from Iran. There is no guarantee that the Secretary of State will renew this waiver with respect to Japanese financial institutions. FATCA In March 2010, the Hiring Incentives to Restore Employment Act enacted certain provisions of the U.S. Internal Revenue Code commonly referred to as Foreign Account Tax Compliance Act (“FATCA”). The purpose of FATCA is to prevent U.S. persons from using offshore accounts to evade U.S. federal income tax. Under FATCA, a 30% withholding tax is imposed on “withholdable payments” (which generally include certain U.S.-source “fixed or determinable annual or periodical” payments and gross proceeds from the disposition of any property that can produce U.S.-source interest or dividends) and “passthru payments” (described below) made to a foreign financial institution (such as ourselves and certain of our banking subsidiaries) that is not a “participating foreign financial institution” (“PFFI”) described below. To avoid the 30% withholding tax on payments it receives, a foreign financial institution is generally required to become a PFFI which is a foreign financial institution that has entered into an agreement with the U.S. Treasury Department pursuant to which it agrees to perform specified due diligence, reporting and withholding functions (a “PFFI agreement”). Specifically, under its PFFI agreement, a PFFI will be required to obtain and report to the U.S. Internal Revenue Service certain information with respect to financial accounts held by U.S. persons or U.S.-owned foreign entities and to withhold 30% from certain payments (“passthru payments”) that it makes to “recalcitrant” accountholders or to non-participating foreign financial institutions. We are currently considering whether we and our subsidiaries will become PFFIs. Becoming a PFFI and complying with a PFFI agreement, would require the establishment of complex internal compliance systems at significant cost. On the other hand, failure to do so could result in the imposition of additional withholding tax on certain payments made to us or our banking subsidiaries. Other In the United States, the Bank’s U.S.-registered broker-dealer subsidiary, SMBC Nikko Securities America, is regulated by the SEC. Broker-dealers are subject to regulations that cover all aspects of the securities business, including:
In addition, SMBC Nikko Securities America is a member of and regulated by the Financial Industry Regulatory Authority and is regulated by the individual state securities authorities in the states in which it operates. The U.S. government agencies and self-regulatory organizations, as well as state securities authorities in the United States having jurisdiction over the Bank’s U.S. broker-dealer affiliates, are empowered to conduct administrative proceedings that can result in censure, fine, the issuance of cease-and-desist orders or the suspension or expulsion of a broker-dealer or its directors, officers or employees. Other Jurisdictions Elsewhere in the world, our operations are subject to regulation and control by local central banks and monetary authorities.
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Table of ContentsThe following chart presents our corporate structure summary at March 31, 2012:
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Table of ContentsAs the ultimate holding company of the Group, we are responsible for:
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Table of ContentsPrincipal Subsidiaries Our principal subsidiaries at March 31, 2012 are shown in the list below. We consolidate all entities over which we control, or have the power to govern the financial and operating policies so as to obtain benefits from their activities. Principal domestic subsidiaries
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Table of ContentsPrincipal foreign subsidiaries
4.D. PROPERTY, PLANT AND EQUIPMENT We own or lease the land and buildings in which we conduct our business. Most of the property that we operate in Japan is owned by us to be used by our branches. In contrast, our international operations are conducted out of leased premises. Our head office building in Marunouchi is leased from a third party. Our largest property is the site of the Bank’s former Otemachi head office, with a net carrying value of ¥122 billion at March 31, 2012. The redevelopment of such property started in April 2011 and is expected to be completed in February 2015. The following table shows the net carrying amount of our tangible fixed assets at March 31, 2012:
For more information, see Note 12 “Property, Plant and Equipment” and Note 38 “Assets Pledged and Received as Collateral” to our consolidated financial statements included elsewhere in this annual report. The total area of land related to our material office and other properties at March 31, 2012 was approximately 753,000 square meters for owned land and approximately 17,000 square meters for leased land. We are not aware of any material environmental issues that may affect the utilization of our assets.
None.
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The discussion below should be read together with “Item 3.A. Selected Financial Data” and our consolidated financial statements and related notes included elsewhere in this annual report. Unless otherwise indicated, we present our information on a consolidated basis. OVERVIEW Operating Environment In the first few months of the fiscal year ended March 31, 2012 the Japanese economy contracted due to a combination of supply chain disruptions, electricity shortages and the consequential slowdown in exports in the aftermath of the Great East Japan Earthquake and its collateral events. The Japanese economy then gradually recovered as the efforts to restore supply chains and make up for the lost output took hold. In the second half of the fiscal year, there were some visible signs of improvement in the unemployment rate despite monthly fluctuations, as the ratio of job offers to applicants continued to improve, although the employment situation in Japan still remains weak partly due to the effects of the earthquake. Private consumption also remained firm. Even though the rate of recovery of the Japanese economy slowed down due to the deceleration of the overseas economy coupled with the persistent strength of the Japanese yen against other currencies, the Japanese economy continued to recover. In Japanese financial and capital markets, short-term interest rates have been stable at low levels, due to the BOJ’s ongoing provision of ample funds. Long-term interest rates have hovered at low levels and the long-term interest rate was around 1.0% at the end of the March 31, 2012 fiscal year. The Nikkei 225 Index, which was ¥9,755.10 at March 31, 2011, decreased to the ¥8,100 level in November 2011. In March 2012, it moved above the ¥10,200 level in response to the strong U.S. stock market, mainly as a result of the improvement in the U.S. economic indicators, and depreciation of the yen. The Nikkei 225 Index was ¥10,083.56 at March 31, 2012. The yen appreciated against both the U.S. dollar and the euro during the fiscal year ended March 31, 2012. It appreciated from the ¥83 level against the U.S. dollar at March 31, 2011 to an all-time peak of the ¥75 level in October 2011. It also appreciated from the ¥117 level against the euro at March 31, 2011 to the ¥97 level in January 2012. The yen then returned to the ¥82 level against the dollar and the ¥110 level against the euro at March 31, 2012, following enhanced monetary easing by the BOJ in February 2012. Corporate bankruptcies in Japan, both in number and the amount of total liabilities are on a downward trend. According to Teikoku Databank, a Japanese research institution, there were approximately 12,900 corporate bankruptcies involving approximately ¥7.0 trillion in total liabilities for the fiscal year ended March 31, 2010, approximately 11,500 corporate bankruptcies involving approximately ¥4.6 trillion in total liabilities for the fiscal year ended March 31, 2011, and approximately 11,400 corporate bankruptcies involving approximately ¥3.9 trillion in total liabilities for the fiscal year ended March 31, 2012. The global economy as a whole showed a weak recovery for the fiscal year ended March 31, 2012. International financial and capital markets continued to decline due to concerns about the European sovereign debt crisis and a tightening of fiscal or monetary policy by emerging economies. The U.S. economy had been picking up because of a moderate increase in production and a recovery of consumption in the second half of the fiscal year ended March 31, 2012. Economic growth in Europe has slowed in some countries. Several European nations were experiencing recessionary conditions in the second half of the fiscal year ended March 31, 2012. Although the establishment of the European Financial Stability Facility and purchases of sovereign debt by the European Central Bank have led to some progress towards remedying the European sovereign debt crisis in Greece and other countries, uncertainty remains in some countries due to
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Table of Contentsconcerns about fiscal stability. China, India and other emerging economies in Asia are expected to grow further. However their rates of growth have been declining since the second half of the fiscal year ended March 31, 2012. For further information on exposures to certain European countries, see “Item 5.A Operating Results—Exposures to Selected European Countries.” In response to the Great East Japan Earthquake, the Government of Japan has engaged in revitalization efforts. The Basic Act on Reconstruction from the Great East Japan Earthquake, including the establishment of a reconstruction agency for planning and coordination of national policies and measures for reconstruction, entered into force in June 2011. On December 2, 2011, the Government of Japan enacted a third supplementary budget for the fiscal year ended March 31, 2012, mainly intended to promote recovery and reconstruction from the earthquake and nuclear damages, and which included special tax measures for funding the restoration from the earthquake. Although the budget includes special tax measures for funding the restoration from the earthquake, the statutory corporation tax rate will be reduced pursuant to an amendment to the Corporation Tax Act. For a more detailed description of changes in Japanese corporation tax rates, see “Item 5.A. Operating Results—Income Tax Expense.” In addition to economic factors and conditions, we expect that our financial condition and operating results will be significantly affected by regulatory trends. To address perceived weaknesses in financial regulation revealed by the global financial crisis, regulatory authorities in Japan and foreign countries have been and may continue taking significant steps to enhance regulation of the financial sector. The Basel Committee and other international bodies are leading efforts to formulate enhanced regulations, including in the areas of capital adequacy and liquidity. The Basel Committee published the Basel III rules text in December 2010, reflecting agreement on global regulatory standards on capital adequacy and liquidity of internationally active banks. To reflect changes made by the Basel Committee, the FSA changed its capital adequacy guidelines. The FSA’s changes will be generally applied from March 31, 2013, and will generally reflect the main measures of the minimum capital requirements of the Basel Committee that are scheduled to be phased in starting January 1, 2013. For a more detailed description of the capital adequacy rules based on Basel III, see “Item 4.B. Business Overview—Regulation.” Japanese banks are facing increased scrutiny over their credit policies relating to SMEs and residential mortgage loans. The Act Concerning Temporary Measures to Facilitate Financing for SMEs, etc., which took effect on December 4, 2009, requires financial institutions to, among other things, make an effort to reduce their customers’ burden of loan repayments through methods such as term modification at the request of eligible borrowers, including SMEs and individual housing loan borrowers. The law was initially established as a short term measure to be effective until March 2011 but in March 2012 the application period was re-extended until March 2013. For a more detailed description of the Act Concerning Temporary Measures to Facilitate Financing for SMEs, etc., see “Item 4.B. Business Overview—Regulation.” In the United States, the Dodd-Frank Act which was enacted in July 2010, provides a broad framework for significant regulatory changes across most areas of U.S. financial regulation. The Dodd-Frank Act addresses, among other issues, systemic risk oversight, bank capital standards, the liquidation of failing systemically significant U.S. financial institutions, OTC derivatives, the ability of banking entities to engage in proprietary trading activities and invest in hedge funds and private equity funds (known as the “Volcker Rule”), consumer and investor protection, hedge fund registration, securitization, investment advisors and the role of credit-rating agencies. For a more detailed description of the Dodd-Frank Act, see “Item 4.B. Business Overview—Regulation.” For a more detailed description of regulations to which we are subject to, risks associated with regulatory development and our management policy under this environment, see “Item 3.D. Risk Factors—Risks Related to Our Business, and Risks Related to Our Industry,” “Item 4.B. Business Overview—Regulation,” and “Item 4.B. Business Overview—Management Policies.”
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Table of ContentsFactors Affecting Results of Operation Income (Loss) We have three principal sources of operating income: net interest income, net fee and commission income, and net trading/investment income. Income other than these three principal sources is included in “Other income.” Net Interest Income. Net interest income, or the difference between interest income and interest expense, is determined by:
Our principal interest-earning assets are loans and advances, investment securities, and deposits with banks. Our principal interest-bearing liabilities are deposits, borrowings and debt securities in issue. The interest income and expense on trading assets and liabilities are not included in net interest income. Our net interest income is earned mainly by the Bank. The Bank controls its exposure to interest rate fluctuations through asset and liability management operations. The Bank, like other banks in Japan, makes most domestic loans based on a short-term interest rate, the Tokyo Interbank Offered Rate (“TIBOR”), or a short-term prime rate, which are generally intended to reflect its cost of short-term yen funding. The Bank’s short-term prime rate is affected mainly by changes in the policy interest rates set by the BOJ, which is an uncollateralized overnight call rate. Prime rates in Japan have been relatively stable since 2000. This is mainly because short-term interest rates, for example, the three-month TIBOR, have declined to nearly zero, and prime rates, which are adjusted according to changes in short-term interest rates, had little room for further decline. The BOJ lowered its target for the uncollateralized overnight call rate from 0.5% to 0.3% on October 31, 2008 and by an additional 0.2 percentage point to 0.1% on December 19, 2008 in order to address market conditions. Following these policy interest rate changes, we lowered our short-term prime rate by 0.2 percentage point from 1.675% to 1.475% on January 13, 2009 and our ordinary deposit rate by 0.02 percentage point from 0.04% to 0.02% on September 13, 2010. On October 5, 2010, the BOJ lowered its target for the uncollateralized overnight call rate to a range of 0% to 0.1% in order to enhance monetary easing, making clear that it is pursuing a virtual zero interest rate policy. Moreover, on February 14, 2012, the BOJ clarified its monetary policy stance and decided to further enhance monetary easing, with the aim of achieving the goal of 1% year-on-year rate of increase in the consumer price index. The following table sets forth the Bank’s short-term prime rate, three-month TIBOR, ordinary deposit rate, long-term prime rate and ten-year swap rate, at the dates indicated:
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Table of ContentsIt is difficult to earn a wide interest spread when interest rates are at a low level, as they currently are in Japan. When interest rates rise from extremely low levels, interest spreads at commercial banks generally increase. However, interest spreads may temporarily decrease immediately after an increase in interest rates because it may take time for banks to increase lending rates correspondingly, in contrast to their funding rates. After an adjustment period, lending rates generally also increase and banks are able to secure a wider interest spread than in a low interest rate environment. Conversely, interest spreads may temporarily increase immediately after a decrease in interest rates because it may take time for banks to decrease lending rates correspondingly, in contrast to their funding rates. After an adjustment period, lending rates generally also decrease and banks generally are not able to maintain a wide interest spread. While various factors may affect the level of net interest income, generally the loan-to-deposit interest spread increases when short-term interest rates rise, particularly in the current low interest-rate environment. Net Fee and Commission Income. We earn fees and commissions from a variety of services. The primary components of the Bank’s net fee and commission income are fees and commissions related to money remittances and transfers, investment trusts, loans (such as loan commitment fees and loan arrangement fees), securities transactions (such as bond trustee fees and bond recording agency fees) and guarantees and acceptances. Other fees and commissions include fees from investment banking and electronic banking. In addition, we earn a significant amount of fees and commissions from our credit card business, conducted through Sumitomo Mitsui Card and Cedyna, and from our securities business, conducted through SMBC Nikko Securities and SMBC Friend Securities. The principal components of Sumitomo Mitsui Card’s and Cedyna’s fees and commissions are membership fees from retailers and annual cardholder membership fees, while those of SMBC Nikko Securities’ and SMBC Friend Securities’ fees and commissions are subscription and agent commissions from investment trusts and underwriting commissions. The principal factors affecting fees and commissions are the demand for the services provided, the fees charged for those services and fees charged by competitors for similar services. The volume of services provided also affects profitability, as our fee businesses have significant economies of scale. In order to diversify sources of revenue and enhance return on assets, we are expanding our fees and commissions businesses, including sales of investment trusts and pension-type insurance, and investment banking businesses. Net Trading/Investment Income. We undertake significant trading activities involving a variety of financial instruments, including derivatives. Our income from these activities is subject to volatility caused by, among other things, changes in interest rates, exchange rates, equity prices or other market variables. Any unexpected change in interest rates could affect the fair value of our interest rate derivative positions and our net income from trading activities. Net trading income consists of margins made on market-making and our customer business as well as changes in fair value of trading assets and liabilities and derivative financial instruments. It also includes net interest and dividend income on these instruments. We have hybrid instruments classified as financial assets at fair value through profit or loss in our consolidated financial statements. Net income from financial assets at fair value through profit or loss includes gains and losses arising from sales and the change in the fair value of these instruments. It also includes interest and dividend income on these instruments. We have substantial investments in debt securities as available-for-sale financial assets. In particular, Japanese government bonds represent a significant part of our bond portfolio. We also own debt securities denominated in foreign currencies, principally the U.S. dollar. We also have investments in equity securities as available-for-sale financial assets, which include our strategic investments in stocks issued by our customers. Net investment income includes the gains and losses arising from the sales or redemptions of available-for-sale financial assets and the dividend income earned from available-for-sale equity instruments. Increases in interest rates or declines in equity prices could substantially decrease the fair value of our available-for-sale financial assets.
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Table of ContentsOther Income. Other income consists primarily of income from operating leases conducted by Sumitomo Mitsui Finance and Leasing and income related to IT solution services. Expenses Impairment Charges on Financial Assets. Our impairment charges are recorded mainly due to impairment charges on loans and advances and on investment securities. Impairment charges on loans and advances are affected by the economic environment. During periods of economic slowdown, corporate and individual borrowers are generally more likely to suffer credit rating downgrades, or become delinquent or default on their borrowings. The slowdown in the domestic or global economy may increase credit costs relating to a wide range of industries. Declines in market prices for domestic and foreign investment securities may result in our recording impairment charges. We assess at the end of each reporting period whether there is any objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity instruments classified as available-for-sale, a significant or prolonged decline in the fair value of the instrument below its cost is also considered to be such evidence in determining whether the assets are impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss, measured as the difference between the cost and the current fair value less any impairment charges on that financial asset previously recognized in profit or loss, is removed from equity and recognized in profit or loss. General and Administrative Expenses. General and administrative expenses consist primarily of personnel expenses (salaries and related expenses), depreciation and amortization expenses, and other expenses (rent and lease expenses, premiums for deposit insurance, advertising and marketing expenses, and communication expenses). Other Expenses. Other expenses consist primarily of cost of operating leases, costs related to IT services, losses on disposal of property, plant and equipment and other intangible assets and impairment losses of property, plant and equipment. Unrealized Gains or Losses on Investment Securities Portfolio Changes in the fair value of domestic and foreign investment securities result in an increase or a decrease in unrealized gains or losses on available-for-sale financial assets. Unrealized gains or losses arising from changes in the fair value of investment of these securities are recognized directly in equity, until they are derecognized or impaired. Most of our domestic equity instruments consist of publicly traded Japanese stocks. The Nikkei 225 Index decreased by 12.0% from ¥11,089.94 at March 31, 2010, to ¥9,755.10 at March 31, 2011, but increased by 3.4% to ¥10,083.56 at March 31, 2012. At March 31, 2012, we had net unrealized gains on domestic equity securities of ¥916,457 million, an increase of ¥67,204 million from ¥849,253 million at March 31, 2011. For more information, see “Item 5.A. Operating Results—Financial Condition—Investment Securities.” Strengthening of Equity Capital In response to more stringent regulatory capital requirements, we have been taking a proactive approach to managing our risk-weighted capital ratio by focusing on increasing our qualifying capital, including through measures such as global common stock offerings, identifying risks and controlling risk-weighted assets. As a result of global offerings of common stock completed in July 2009 and February 2010, we increased our equity in our consolidated statement of financial position by ¥1,836 billion. In September and October 2009, we issued into the domestic market ¥388 billion of preferred securities via a consolidated subsidiary, the proceeds of which
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Table of Contentswere used to improve our capital. In February 2010, we completed cash tender offers whereby we repurchased the majority of the outstanding series of certain non-cumulative perpetual preferred securities and the Bank repurchased the majority of the outstanding series of our fixed to floating rate perpetual subordinated bonds. The successful tender offers reduced our interest and dividend payment obligations with respect to those securities, and together with associated gains, improved the quantity and quality of our capital. In addition, on April 1, 2011, we acquired and cancelled all shares of our Type 6 preferred stock for an aggregate amount of ¥210 billion. Foreign Currency Fluctuations The average exchange rate used to convert dollars to yen in the consolidated financial statements included elsewhere in this annual report for the fiscal year ended March 31, 2012 was ¥79.08 per $1.00, compared to the prior fiscal year’s average exchange rate of ¥85.74 per $1.00. The percentage of revenue we earned from our foreign operations for the fiscal years ended March 31, 2012 and 2011 was 12% and 10%, respectively. For more information, please see “Item 4.B. Business Overview—Revenues by Region.” Critical Accounting Estimates and Judgments Our financial position and operating results are influenced by estimates and judgments that management employs in the course of preparation of our consolidated financial statements. We identified the following areas of significant accounting policies to be particularly sensitive in terms of estimates and judgments made by management. Estimates and judgments are continually evaluated based on historical experience and other factors, including expectations of future events that are believed to be reasonable. Allowance for Loan Losses Allowance for loan losses represents management’s estimate of the losses incurred in the loan portfolios at the end of each reporting period. Management exercises judgments in making assumptions and estimations when calculating the allowance for loan losses on both individually and collectively assessed loans. The allowance for loan losses for individually significant impaired loans is estimated by management based on 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, the overall support from financial institutions and realizable value of any collateral held. The allowance for loan losses is the difference between the carrying amount of a loan and the discounted present value of expected future cash flows that are estimated by management. The actual future cash flows may differ from the estimates by management and consequently may cause actual loan losses to differ from the reported allowance for loan losses. The allowance for loan losses for the remaining loans is collectively calculated based on the historical loss experience for loans which have similar credit risk characteristics to those in the current loan portfolio using statistical methods. These statistical methods are subject to estimation uncertainty. In normal circumstances, the use of statistical methods evidenced by historical information provides the most objective methodology in assessing inherent losses on loans with similar credit risk characteristics. However, in certain circumstances, the use of historical loss experience alone may not be representative of current loss experiences and as a result it may provide less relevant information about the loss incurred in a given portfolio at the end of the reporting period, particularly in a situation where there have been changes in economic conditions. In these circumstances, we make a judgment to update the historical loss experience based on the most recent loss information, taking into account, among others, the effect of the current economic environment. Additionally, we recognize an allowance for loan losses when it is probable that a loss has been incurred but not yet reported to us. To assess the losses on the loan portfolios where loss events have occurred but not yet been reported, management develops assumptions and methodologies.
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Table of ContentsManagement estimates and judgments may change from time to time as the economic environment changes or new information becomes available. Changes in these estimates and judgments will result in a different allowance for loan losses and may have a direct impact on impairment charges. The impairment charges for loan losses totaled ¥144,022 million, ¥259,292 million and ¥215,886 million for the fiscal years ended March 31, 2012, 2011 and 2010, respectively. Fair Value of Financial Instruments Some of our financial instruments are measured at fair value with changes in fair value recognized in profit or loss, such as trading assets and liabilities, financial assets at fair value through profit or loss, and derivative financial instruments. Available-for-sale financial assets are also measured at fair value with changes in fair value reported in other comprehensive income. The fair value of a financial instrument is the amount for which the instrument could be exchanged or settled between knowledgeable and willing parties in an arm’s length transaction. Our financial assets and liabilities measured at fair value are mostly valued based on observable market data that are readily available in active markets, or using valuation techniques that incorporate inputs, other than quoted market prices, that are observable either directly or indirectly in the market, including dealers’ quotes. We principally use valuation techniques that are commonly used by market participants to price the instruments. To the extent practical, the valuation models make maximum use of observable data. However, for certain financial assets and liabilities, the fair values are measured by using valuation techniques with significant unobservable inputs. In such cases, significant management estimates are made, resulting in a less objective measurement of fair value. The risk management departments in each subsidiary regularly review significant valuation methodologies and recalibrate model parameters and inputs, both observable and unobservable, in an effort to ensure an appropriate estimation of fair value has been made. Where significant management judgments are required in valuation, we establish a valuation control framework to validate the valuation models and fair values calculated based on such valuation models. Under the framework, the accounting department is responsible for ensuring that the accounting policies and procedures to determine the fair values are in compliance with the relevant accounting standards. If there are significant unobservable inputs used in the valuation technique at the trade date and financial assets and liabilities are not recognized at their respective transaction prices, any profit or loss on the trade date is deferred. Management judgment is required to determine whether significant unobservable inputs exist in the valuation technique. The financial assets and liabilities carried at fair value were categorized under the three levels of fair value hierarchy as follows:
Management judgment is involved in determining the level of hierarchy to which each financial instrument should be categorized and in periodical assessments of market liquidity for inputs and price transparency. In addition to the fair value hierarchy disclosure, we provide a sensitivity analysis of the impact on the Level 3 financial instruments of using reasonably possible alternatives for the unobservable parameters in Note 44 “Fair Value of Financial Assets and Liabilities” to our consolidated financial statements included elsewhere in this annual report. The determination of reasonably possible alternatives requires significant management judgment.
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Table of ContentsThe financial assets measured at fair value categorized in Level 3 were ¥1,000,426 million and ¥1,040,285 million at March 31, 2012 and 2011, respectively. The financial liabilities measured at fair value categorized in Level 3 were ¥17,470 million and ¥7,351 million at March 31, 2012 and 2011 respectively. Impairment of Available-for-sale Financial Assets Available-for-sale financial assets are measured at fair value with changes in fair value reported in available-for-sale financial assets reserve as a separate component of equity until the financial assets are either derecognized or become impaired. If there is objective evidence of impairment as a result of loss events which have an impact on the estimated future cash flows of the financial assets that can be reliably estimated, the cumulative loss previously recognized in equity is removed and recognized in profit or loss as an impairment charge. We exercise judgment in determining whether there is objective evidence of occurrence of loss events which result in a decrease in estimated future cash flows. The estimation of future cash flows also requires judgment. In the assessment of impairment of available-for-sale equity instruments, we also consider whether there has been a significant or prolonged decline in fair value below their cost. The determination of what is a significant or prolonged decline requires management judgment. Impairment may occur when there is objective evidence of deterioration in the financial conditions of the investee, industry and sector performance, or changes in operating and financing cash flows. The determination of impairment in this respect also includes significant management judgment. Management estimates and judgments may change from time to time upon future events that may or may not occur and changes in these estimates and judgments could adversely affect the carrying amounts of available-for-sale financial assets. Impairment charges on available-for-sale financial assets reclassified from equity to profit or loss totaled ¥140,288 million, ¥174,636 million and ¥42,755 million for the fiscal years ended March 31, 2012, 2011 and 2010, respectively. Impairment of Goodwill Goodwill is tested for impairment at least annually and whenever events or changes in circumstances indicate that it may be impaired. The first step of the impairment test is identifying the cash-generating units (“CGUs”), which represent the smallest identifiable groups of assets that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Goodwill is then allocated to the CGUs, considering how the goodwill is recognized and other relevant factors. In the impairment test, the carrying amount of the CGU to which goodwill is allocated is compared against its recoverable amount, which is the higher of its fair value less costs to sell and its value in use. Such recoverable amounts are determined based on significant management judgments and assumptions. We determine the recoverable amount using the estimated future cash flows, pre-tax discount rates, growth rates and other factors. The estimation of future cash flows inherently reflects management judgments, even though such forecasts are prepared taking into account actual past performance and external economic data. The pre-tax discount rates and growth rates may be significantly affected by market interest rates or other market conditions, which are beyond management’s control, and therefore significant management judgments are made to determine these assumptions. These management judgments are made based on the facts and circumstances at the time of the impairment test, and may vary depending on the situation and time. Changes in management judgments may result in different impairment test results and different impairment losses recognized. For the fiscal years ended March 31, 2012, 2011 and 2010, impairment losses on goodwill were ¥1,884 million, nil and ¥3,918 million, respectively.
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Table of ContentsProvision for Interest Repayment Provision for interest repayment represents management’s estimate of future claims for the refund of gray zone interest, taking into account historical experience such as the number of customer claims for a refund, the amount of repayments and the customers’ characteristics, and the length of the period the claims are expected to be received in the future. Management estimates and judgments may change from time to time as the legal environment and market conditions change or new information becomes available. Changes in these estimates and judgments could affect the balance of provision for interest repayment. Provision for interest repayment is recorded in provisions as a liability, and it totaled ¥400,233 million and ¥72,219 million at March 31, 2012 and 2011, respectively. The increase in provision for interest repayment was due mainly to the inclusion of the provision from SMBC Consumer Finance, formerly known as Promise, which became our consolidated subsidiary in December 2011. Retirement Benefits We have defined benefit plans such as defined benefit pension plans and lump-sum severance indemnity plans. The present value of the defined benefit obligation is calculated based on actuarial valuations that are dependent upon a number of assumptions, including discount rates, mortality rates and future salary (benefit) increases. The discount rates are equivalent to market yields of AA credit-rated corporate bonds that have terms to maturity approximating those of the related obligations. Future mortality rates are based on the official mortality table generally used for actuarial assumptions in Japan. Other assumptions used for the calculation of the defined benefit obligation are based on historical records. The expected return on plan assets is developed separately for each plan, typically using a building block approach recognizing the plan’s specific asset allocation and the assumed return on assets for each asset category. Due to the long-term nature of these plans, such estimates are subject to significant uncertainty. While we believe that these assumptions are appropriate, any change in these assumptions will impact actuarial gains and losses, as well as the present value of the defined benefit obligations and the net retirement benefit expense for each period. Actuarial gains and losses in excess of the greater of 10% of the fair value of plan assets and 10% of the present value of the defined benefit obligation are recognized in profit or loss over the employees’ expected average remaining working lives. The amounts of cumulative unrecognized actuarial losses, net of gains, at March 31, 2012 and 2011 were ¥307,776 million and ¥210,534 million, respectively. The difference between the fair value of the plan assets and the present value of the defined benefit obligation at the end of the reporting period, adjusted for any cumulative unrecognized actuarial gains and losses and past service costs for each plan, is recognized as liabilities and assets in the consolidated statement of financial position. When this calculation for each plan results in a benefit to us, the recognized asset is limited to the net total of any cumulative unrecognized actuarial losses and past service costs and the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan. An economic benefit is available to us, if it is realizable during the life of the plan or on settlement of the plan obligation. Our cumulative deficit at March 31, 2012 and 2011 was ¥184,675 million and ¥124,705 million, respectively, while the net total of assets and liabilities in the consolidated statement of financial position amounted to net assets of ¥122,799 million and ¥85,318 million at March 31, 2012 and 2011, respectively. Deferred Tax Assets We recognize deferred tax assets relating to tax losses carried forward and deductible temporary differences, only to the extent that it is probable that future taxable profit will be available against which the tax losses carried forward and the deductible temporary differences can be utilized. This assessment requires significant management judgments and assumptions. Future taxable profit is estimated based on, among other relevant factors, forecasted operating results, which are based on historical financial performance and the business plans that management believes to be prudent and feasible. While we carefully assess the realization of tax losses
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Table of Contentscarried forward and deductible temporary differences, the actual taxable profit in the future may be less than the forecast. The net deferred tax assets amounted to ¥562,890 million and ¥1,001,140 million at March 31, 2012 and 2011, respectively. Special Purpose Entities In the ordinary course of business, we are involved in a number of transactions using vehicles which may be deemed as special purpose entities (“SPEs”), in areas including the securitization of financial assets. We consolidate SPEs, if our control is considered substantive with respect to the SPEs as required by IFRS. In assessing and determining whether we control SPEs, judgment is made to determine whether (a) the activities of the SPE are being conducted on our behalf according to our specific business needs so that we obtain benefits from the SPE’s operations, (b) we have the decision-making powers to obtain the majority of the benefits of the activities of the SPE or we have delegated these decision-making powers by setting up an autopilot mechanism, (c) we have rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE, or (d) we retain the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities. In many instances, the indicators of control of an SPE are clear, in which case less management judgment is required. In some cases, however, several different indicators of control that would support different conclusions may exist, in which case more management judgment is required to form an overall conclusion on control. For more information, see “Item 5.E. Off-balance Sheet Arrangements.” New and Amended Standards and Recent Accounting Pronouncements See “New and amended standards adopted by the SMFG Group” and “Recent Accounting Pronouncements” under Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements included elsewhere in this annual report. Under the economic and financial circumstances described in “Item 5. Overview—Operating Environment”, we made a profit through our commercial banking and other financial services businesses. Our total operating income decreased by ¥43,742 million from ¥2,878,245 million for the fiscal year ended March 31, 2011 to ¥2,834,503 million for the fiscal year ended March 31, 2012 primarily due to a decrease of net trading income. In spite of this, our net operating income increased by ¥105,876 million from ¥2,444,317 million for the fiscal year ended March 31, 2011 to ¥2,550,193 million for the fiscal year ended March 31, 2012, primarily due to a decrease in impairment charges on loans and advances. However, our net profit decreased by ¥113,520 million from ¥571,518 million for the fiscal year ended March 31, 2011 to ¥457,998 million for the fiscal year ended March 31, 2012, due to an increase in general and administrative expenses and income tax expense. Our total assets increased by ¥5,403,499 million from ¥136,470,927 million at March 31, 2011 to ¥141,874,426 million at March 31, 2012, primarily due to an increase in investment securities and loans and advances. Our total liabilities increased by ¥5,339,313 million from ¥128,919,722 million at March 31, 2011 to ¥134,259,035 million at March 31, 2012, primarily due to an increase in deposits and debt securities in issue, which was partially offset by a decrease in borrowings. Our total equity increased by ¥64,186 million from ¥7,551,205 million at March 31, 2011 to ¥7,615,391 million at March 31, 2012, due primarily to an increase in retained earnings and other reserves, although capital surplus decreased and treasury stock increased.
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Table of ContentsOperating Results The following table presents information as to our income, expenses and net profit for the fiscal years ended March 31, 2012, 2011 and 2010:
Fiscal Year Ended March 31, 2012 Compared to Fiscal Year Ended March 31, 2011 Total operating income decreased by ¥43,742 million, or 2%, from ¥2,878,245 million for the fiscal year ended March 31, 2011 to ¥2,834,503 million for the fiscal year ended March 31, 2012, primarily due to a decrease in net trading income of ¥142,183 million, which was partially offset by an increase in net fee and commission income. Net operating income increased by ¥105,876 million from ¥2,444,317 million for the fiscal year ended March 31, 2011 to ¥2,550,193 million for the fiscal year ended March 31, 2012. The primary reason of this increase was a decrease in impairment charges on loans and advances. Net profit decreased from ¥571,518 million for the fiscal year ended March 31, 2011 to ¥457,998 million for the fiscal year ended March 31, 2012 as a result of an increase in both general and administrative expenses
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Table of Contentsand income tax expense resulting from a reduction of net deferred tax assets which resulted mainly from changes in Japanese corporation tax rates which will be applied after the fiscal years beginning April 1, 2012. For a more detailed description of changes in Japanese corporation tax rates, see “Item5.A. Operating Results—Income Tax Expense.” Fiscal Year Ended March 31, 2011 Compared to Fiscal Year Ended March 31, 2010 Total operating income increased by ¥113,692 million, or 4%, from ¥2,764,553 million for the fiscal year ended March 31, 2010 to ¥2,878,245 million for the fiscal year ended March 31, 2011. The primary reason for this increase was an increase in net fee and commission income of ¥145,423 million due mainly to the effect of the inclusion of full year impact of SMBC Nikko Securities, which became a subsidiary in October 2009, and the acquisition of Cedyna in May 2010. In addition, net investment income increased by ¥57,359 million due primarily to an increase in gains on sales of bonds by quickly responding to fluctuations in the market interest rates at the Bank. These were partially offset by decreases in net interest income, which was driven by a decline in market interest rates, and net income from financial assets at fair value through profit or loss due primarily to a decrease in gains on debt instruments. Net operating income decreased by ¥61,595 million from ¥2,505,912 million for the fiscal year ended March 31, 2010 to ¥2,444,317 million for the fiscal year ended March 31, 2011. The primary reason of this decrease was an increase in impairment charges on available-for-sale financial assets. Net profit decreased from a net profit of ¥646,693 million for the fiscal year ended March 31, 2010 to a net profit of ¥571,518 million for the fiscal year ended March 31, 2011 as a result of a decrease in net operating income described above and an increase in general and administrative expenses due to the inclusion of full year impact of SMBC Nikko Securities in October 2009 and the acquisition of Cedyna in May 2010.
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Table of ContentsNet Interest Income The following tables show the average balances of our statements of financial position items and related interest income and expense, and average rates for the fiscal years ended March 31, 2012, 2011 and 2010:
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Table of ContentsThe following tables show changes in our net interest income based on changes in volume and changes in rate for the fiscal year ended March 31, 2012 compared to the fiscal year ended March 31, 2011, and those for the fiscal year ended March 31, 2011 compared to the fiscal year ended March 31, 2010:
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