20-F 1 d183684d20f.htm ANNUAL REPORT ANNUAL REPORT
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

   For the fiscal year ended March 31, 2016

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

   For the transition period from                      to                     

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

   Date of event requiring this shell company report

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)

 

Japan    1-2, Marunouchi  1-chome, Chiyoda-ku, Tokyo 100-0005, Japan
(Jurisdiction of incorporation or organization)    (Address of principal executive offices)

Takeshi Mikami

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

 

Title of Each Class

 

Name of Each Exchange on which registered

Common stock, without par value

  The New York Stock Exchange*

 

* Not for trading, but only in connection with the listing of the American Depositary Shares, each American Depositary Share representing 1/5 of one share of the registrant’s common stock.

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, 2016, the following shares of capital stock were outstanding: 1,414,055,625 shares of common stock (including 46,830,882 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):

 

Large Accelerated Filer  x   Accelerated Filer  ¨    Non-accelerated Filer  ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  ¨    International Financial Reporting Standards as issued by the International Accounting Standards Board  x    Other  ¨

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

 

 

 


Table of Contents

TABLE OF CONTENTS

 

              Page  

Certain Defined Terms, Conventions and Presentation of Financial Information

     1   

Cautionary Statement Regarding Forward-Looking Statements

     2   

PART I

     3   
  Item 1.    Identity of Directors, Senior Management and Advisers      3   
  Item 2.    Offer Statistics and Expected Timetable      3   
  Item 3.    Key Information      3   
      3.A.    Selected Financial Data      3   
      3.B.    Capitalization and Indebtedness      5   
      3.C.    Reasons for the Offer and Use of Proceeds      5   
      3.D.    Risk Factors      5   
  Item 4.    Information on the Company      19   
      4.A.    History and Development of the Company      19   
      4.B.    Business Overview      20   
      4.C.    Organizational Structure      55   
      4.D.    Property, Plant and Equipment      57   
  Item 4A.    Unresolved Staff Comments      58   
  Item 5.    Operating and Financial Review and Prospects      58   
      5.A.    Operating Results      67   
      5.B.    Liquidity and Capital Resources      109   
      5.C.    Research, Development, Patents and Licenses      114   
      5.D.    Trend Information      114   
      5.E.    Off-Balance Sheet Arrangements      114   
      5.F.    Tabular Disclosure of Contractual Obligations      115   
      5.G.    Safe Harbor      115   
  Item 6.    Directors, Senior Management and Employees      115   
      6.A.    Directors and Senior Management      115   
      6.B.    Compensation      123   
      6.C.    Board Practices      123   
      6.D.    Employees      127   
      6.E.    Share Ownership      128   
  Item 7.    Major Shareholders and Related Party Transactions      130   
      7.A.    Major Shareholders      130   
      7.B.    Related Party Transactions      131   
      7.C.    Interests of Experts and Counsel      131   
  Item 8.    Financial Information      131   
      8.A.    Consolidated Statements and Other Financial Information      131   
      8.B.    Significant Changes      132   
  Item 9.    The Offer and Listing      132   
      9.A.    Offer and Listing Details      132   
      9.B.    Plan of Distribution      134   
      9.C.    Markets      134   
      9.D.    Selling Shareholders      134   
      9.E.    Dilution      135   
      9.F.    Expenses of the Issue      135   
  Item 10.    Additional Information      135   
      10.A.    Share Capital      135   
      10.B.    Memorandum and Articles of Incorporation      135   
      10.C.    Material Contracts      145   
      10.D.    Exchange Controls      145   

 

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              Page  
      10.E.    Taxation      146   
      10.F.    Dividends and Paying Agents      150   
      10.G.    Statement by Experts      150   
      10.H.    Documents on Display      151   
      10.I.    Subsidiary Information      151   
  Item 11.    Quantitative and Qualitative Disclosures about Credit, Market and Other Risk      151   
  Item 12.    Description of Securities other than Equity Securities      164   
      12.A.    Debt Securities      164   
      12.B.    Warrants and Rights      164   
      12.C.    Other Securities      164   
      12.D.    American Depositary Shares      164   

PART II

     166   
  Item 13.    Defaults, Dividend Arrearages and Delinquencies      166   
  Item 14.    Material Modifications to the Rights of Security Holders and Use of Proceeds      166   
  Item 15.    Controls and Procedures      166   
  Item 16A.    Audit Committee Financial Expert      167   
  Item 16B.    Code of Ethics      167   
  Item 16C.    Principal Accountant Fees and Services      168   
  Item 16D.    Exemptions from the Listing Standards for the Audit Committee      168   
  Item 16E.    Purchases of Equity Securities by the Issuer and Affiliated Purchasers      169   
  Item 16F.    Change in Registrant’s Certifying Accountant      169   
  Item 16G.    Corporate Governance      169   
  Item 16H.    Mine Safety Disclosure      171   

PART III

     172   
  Item 17.    Financial Statements      172   
  Item 18.    Financial Statements      172   
  Item 19.    Exhibits      172   

Signatures

     173   

Selected Statistical Data

     A-1   

Index to Consolidated Financial Statements

     F-1   

 

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CERTAIN 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 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 (“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 our median exchange rates for buying and selling spot dollars, or other currencies, by telegraphic transfer against yen as determined at the end of the relevant fiscal period.

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. Except for capital ratios, which have been truncated, percentage data, unless we state otherwise have been subjected to rounding adjustments for the convenience of the reader.

 

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CAUTIONARY 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 (“Securities Exchange Act of 1934”). 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:

 

   

deterioration of Japanese and global economic conditions and financial markets;

 

   

constraints on our operations due to capital adequacy requirements;

 

   

declines in the value of our securities portfolio;

 

   

changes in the level or volatility of market rates or prices;

 

   

incurrence of significant credit-related costs;

 

   

a significant downgrade of our credit ratings;

 

   

our ability to successfully implement our business strategy through our subsidiaries, affiliates and alliance partners;

 

   

exposure to new risks as we expand the scope of our business;

 

   

the industry specific risks of the consumer finance industry;

 

   

the recoverability of deferred tax assets;

 

   

litigation and regulatory proceedings;

 

   

insufficient liquidity;

 

   

problems of other financial institutions; and

 

   

adverse regulatory developments or changes in government policies.

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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PART I

 

Item 1. Identity of Directors, Senior Management and Advisers

Not applicable.

 

Item 2. Offer Statistics and Expected Timetable

Not applicable.

 

Item 3. Key Information

3.A.    SELECTED FINANCIAL DATA

Selected Financial Data

The following selected financial data at and for each of the five fiscal years ended March 31, 2016, 2015, 2014, 2013 and 2012 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.

 

    For the fiscal year ended and at March 31,  
    2016     2015     2014     2013     2012  
    (In millions, except per share data)  

Consolidated income statement data:

         

Interest income

  ¥     1,872,584      ¥     1,782,621      ¥     1,714,044      ¥     1,725,723      ¥     1,710,331   

Interest expense

    431,101        371,107        320,511        321,570        313,631   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    1,441,483        1,411,514        1,393,533        1,404,153        1,396,700   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fee and commission income

    1,031,680        1,002,766        1,003,169        948,685        869,407   

Fee and commission expense

    131,381        129,253        127,959        127,054        132,562   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net fee and commission income

    900,299        873,513        875,210        821,631        736,845   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net trading income

    462,682        127,759        135,218        105,302        182,296   

Net income from financial assets at fair value through profit or loss

    12,260        22,678        58,586        15,794        33,734   

Net investment income

    375,229        371,064        332,265        223,404        239,365   

Other income

    496,273        525,905        429,541        324,403        245,563   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating income

    3,688,226        3,332,433        3,224,353        2,894,687        2,834,503   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Impairment charges (reversals) on financial assets

    148,356        90,138        (14,275     270,145        284,310   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating income

    3,539,870        3,242,295        3,238,628        2,624,542        2,550,193   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

General and administrative expenses

    1,706,263        1,621,897        1,522,990        1,447,116        1,374,540   

Other expenses

    538,963        505,614        428,780        287,896        238,937   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

    2,245,226        2,127,511        1,951,770        1,735,012        1,613,477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Share of post-tax profit (loss) of associates and joint ventures

    31,056        18,124        19,454        19,593        (25,004
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit before tax

    1,325,700        1,132,908        1,306,312        909,123        911,712   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

    372,878        409,947        414,076        255,300        460,779   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net profit

  ¥ 952,822      ¥ 722,961      ¥ 892,236      ¥ 653,823      ¥ 450,933   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    For the fiscal year ended and at March 31,  
    2016     2015     2014     2013     2012  
    (In millions, except per share data)  

Profit attributable to:

         

Shareholders of Sumitomo Mitsui Financial Group, Inc.

  ¥ 843,920      ¥ 614,070      ¥ 766,388      ¥ 535,976      ¥ 338,260   

Non-controlling interests

    106,129        108,891        125,848        117,847        112,673   

Other equity instruments holders

    2,773        —          —          —          —     

Earnings per share:

         

Basic

  ¥ 617      ¥ 449      ¥ 561      ¥ 396      ¥ 244   

Diluted

    617        449        561        395        243   

Weighted average number of common shares in issue (in thousands of shares)

        1,367,229            1,367,258          1,366,186            1,353,926            1,387,405   

Dividends per share in respect of each fiscal year:

         

Common stock

  ¥ 155      ¥ 125      ¥ 125      ¥ 100      ¥ 100   
  $ 1.38      $ 1.04      $ 1.22      $ 1.06      $ 1.22   

Preferred stock (Type 6)(1)

  ¥ —        ¥ —        ¥ —        ¥ —        ¥ 44,250   
  $ —        $ —        $ —        $ —        $ 539   

Consolidated statement of financial position data:

         

Total assets

  ¥ 180,172,652      ¥ 179,181,466      ¥ 158,631,041      ¥ 147,770,475      ¥ 141,824,796   

Loans and advances

    88,862,371        86,971,716        81,244,982        75,987,057        72,536,813   

Total liabilities

    169,130,553        168,160,616        149,215,851        139,210,786        134,407,940   

Deposits

    125,940,797        115,833,980        108,370,494        101,021,413        92,853,566   

Borrowings

    9,914,129        11,217,052        8,463,363        6,475,543        10,412,858   

Debt securities in issue

    10,829,612        11,051,431        8,769,094        7,950,020        7,377,742   

Total equity

    11,042,099        11,020,850        9,415,190        8,559,689        7,416,856   

Capital stock

    2,337,896        2,337,896        2,337,896        2,337,896        2,337,896   

 

(1) On April 1, 2011, we acquired and cancelled all of the outstanding Type 6 preferred stock.

 

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Exchange 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.

 

     High      Low      Period end      Average(1)  
     (Yen per dollar)  

Fiscal year ended March 31,

           

2012

   ¥ 85.47       ¥ 75.99       ¥ 82.13       ¥ 78.98   

2013

     96.45         77.57         94.01         83.31   

2014

     105.37         92.91         102.88         100.47   

2015

     121.59         101.25         120.15         110.61   

2016

     125.51         111.17         112.62         120.12   

Most recent six months:

           

December

     123.30         120.21         120.53         121.86   

January

     120.81         117.05         120.81         118.34   

February

     121.17         111.98         113.61         115.08   

March

     113.96         111.17         112.62         113.03   

April

     112.39         107.99         109.77         109.84   

May

     110.94         106.46         110.94         109.13   

June (through June 15, 2016)

     110.64         106.06         106.06         107.50   

 

(1) Average exchange rates have been calculated by using the average of the exchange rates on the last day of each month during a fiscal year, except for the monthly average rates, which represent the averages of the exchange rates for each day of the relevant months.

The median exchange rate quotation by the Bank for buying and selling spot dollars by telegraphic transfer against yen on June 15, 2016 was ¥106.06 = $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.

3.D.    RISK FACTORS

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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Risks 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, which would be influenced by the changes of various factors. These include fiscal and monetary policies, and laws, regulations and policies on financial markets. Those factors include, for example, the Japanese consumption tax rate. The Japanese consumption tax rate increased from 5% to 8% in April 2014 and was scheduled to further increase to 10% in April 2017. However, Japan’s Prime Minister announced in June 2016 that the increase in the consumption tax rate to 10% would be postponed until October 2019. In order to proceed with the postponement, the Consumption Tax Act and related laws must be amended. Furthermore, geopolitical instability in various parts of the world, including North Africa, the Middle East, Asia and Eastern Europe and material changes in regional economic or political unions or associations between countries, including, for example, the United Kingdom’s potential exit from the European Union as a result of the referendum held on June 23, 2016, could also contribute to economic instability in those and other regions, which could adversely affect Japanese and global economic conditions.

The deterioration of Japanese and global economic conditions, or financial market turmoil, could result in a worsening of our liquidity and capital conditions, an increase in our credit costs, and an increase in impairment of our investment securities and, as a result, adversely affect our business, financial condition and results of operations.

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 established by the Financial Services Agency of Japan (“FSA”). The current requirements reflect the principal risk-weighted capital measures of the Basel III rules text published by the Basel Committee on Banking Supervision (“BCBS”) in December 2010 and are being phased in from March 2013 to March 2019. Compared to the previous requirements, the current requirements increase both the quality and quantity of the risk-weighted capital base.

With respect to the quality of the capital base, certain capital instruments, including existing preferred securities and subordinated debt, are eligible for inclusion as Tier 1 capital or Tier 2 capital only for the phase-out period. Preferred stocks convertible into common stocks no longer qualify as Common Equity Tier 1 capital but would qualify as Additional Tier 1 capital if they satisfy certain requirements including the requirement of loss absorbency at the point of non-viability under the Basel III rules. In addition, securities with step-up clauses will no longer qualify as Additional Tier 1 capital, and if the relevant security is classified as a liability for accounting purposes, it must satisfy the requirement of loss absorbency at a pre-specified trigger point, which must be 5.125% or more of Common Equity Tier 1 risk-weighted capital ratio as well as the aforementioned requirement of loss absorbency at the point of non-viability to qualify as Additional Tier 1 capital. With respect to Tier 2 capital, under the Basel III rules, the relevant security must satisfy the requirement of loss absorbency at the point of non-viability to qualify as Tier 2 capital, and subordinated debt securities callable at the initiative of the issuer within five years or with step-up clauses can no longer qualify as Tier 2 capital.

With respect to the quantity of the capital base, the minimum Common Equity Tier 1 risk-weighted capital ratios applicable to us and the Bank have been 4.5% since March 2015. Moreover, we are required to hold a capital conservation buffer to withstand future periods of stress and a countercyclical buffer as additional capital to reduce the buildup of systemic risk in periods and locations of excessive credit growth. The capital conservation buffer is being phased in from March 2016, with the current ratio of 0.625% reaching 2.5% by March 2019. As a result, the total minimum Common Equity Tier 1 risk-weighted capital ratio will be increased to 7%, and the total minimum risk-weighted capital ratio will be increased to 10.5% in March 2019. The countercyclical buffer, which is being phased in from March 2016, is calculated as the weighted average of the buffers in effect in the jurisdictions to which we have credit exposure, with a maximum of 2.5% when fully implemented in March 2019.

 

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In addition, in November 2014 and 2015, 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 is updated each year in November, and the requirements for additional capital, in the form of a capital surcharge above the Basel III minimum requirement, have been applied from 2016, initially to those financial institutions identified in November 2014 as G-SIFIs. This requirement is commonly referred to as the G-SIFI capital surcharge. Based on the list, we will be required to maintain an additional 1% of Common Equity Tier 1 capital as a percentage of risk-weighted assets when the requirement is fully applied from 2019. Under the phase-in requirements, we are currently required to maintain 0.25% of Common Equity Tier 1 capital as a percentage of risk-weighted assets. G-SIFIs will also be subject to a global standard for Total Loss-Absorbing Capacity (“TLAC”), which defines certain minimum requirements for total loss-absorbing capacity so that if G-SIFIs fail, they will have sufficient loss absorbing and recapitalization capacity available in resolution. In November 2015, the FSB published the final TLAC standard. As a G-SIFI, we will be subject to the final TLAC standard, as implemented in Japan.

At March 31, 2016, on a consolidated basis, our total risk-weighted capital ratio, Tier 1 risk-weighted capital ratio and Common Equity Tier 1 risk-weighted capital ratio were 17.02%, 13.68% and 11.81%, compared to the minimum required ratios of 8.875%, 6.875% and 5.375%, respectively. All the minimum required ratios stated above include the capital conservation buffer of 0.625% and the G-SIFI capital surcharge of 0.25%, but exclude the countercyclical buffer requirements.

Our and the Bank’s capital ratios could decline as a result of decreases in Tier 1 and Tier 2 capital or increases in risk-weighted assets. The following circumstances, among others, could reduce our risk-weighted capital ratio and that of the Bank:

 

   

declines in the value of securities;

 

   

inability to refinance subordinated debt obligations or preferred securities with those qualified as regulatory capital under the new capital adequacy requirements which phased in from March 2013; and

 

   

increases in risk-weighted assets resulting from business growth, strategic investments, borrower downgrades or changes in parameters such as probability of default (“PD”).

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.

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, 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. Failure to maintain capital levels under the capital buffer requirements under Basel III and the requirement for the G-SIFI capital surcharge will result in restrictions on capital distributions, such as dividends, share buybacks, discretionary payments on other Tier 1 capital instruments and bonuses. 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, results of operations and regulatory capital position.

The reported value of our available-for-sale equity instruments accounted for 2.9% of our total assets at March 31, 2016, approximately 89.0% of which were Japanese equity securities. This value depends mainly on

 

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prices of the instruments in the stock market. In addition, the reported value, gross unrealized gains and losses, and cost of those available-for-sale equity instruments at March 31, 2016 are described in “Item 5.A. Operating Results—Investment Securities.”

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. 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 will further reduce our holdings of equity securities in order to reduce financial risks. Any disposal by us of equity holdings of 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. For example, we have substantial investments in debt securities. At March 31, 2016, we had ¥7 trillion of Japanese government bonds classified as available-for-sale financial assets, which accounted for approximately 3.6% of our total assets.

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. 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.

Our non-performing loans (“NPLs”) and credit costs for corporate and individual customers may increase significantly if:

 

   

domestic or global economic conditions worsen or do not improve;

 

   

our customers do not repay their loans, due to reasons including deterioration of their financial conditions; and

 

   

the value of collateral declines.

We have substantial exposure to corporate customers in the following sectors: real estate and goods rental and leasing, manufacturing, wholesale and retail, transportation, communications and public enterprises, and services, including electric utilities, and to individual customers mainly through housing loans. The financial conditions of those customers may be subject to changes in the industry-specific economic conditions, including, for example, fluctuations in oil and gas and other natural resource prices, as well as general economic conditions. In addition, adverse region-specific economic conditions could worsen our customers’ financial conditions or could decrease the value of our collateral provided to us in such regions. As a result, we may be required to record increases in our allowance for loan losses.

 

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Moreover, 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. 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 natural disasters or other calamities.

In addition, changes in laws or government policies may have an adverse impact on the rights of creditors. For example, the Government of Japan has provided or may provide in the future government guarantees and other government support measures in response to the financial crisis or other unexpected incidents such as the Great East Japan Earthquake of March 2011 and collateral events. Even if our current or future loans to borrowers have received or will receive any government support measures, it is unclear to what extent those loans will benefit, directly or indirectly, from the current or any future government guarantees or support measures.

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 0.8%, 1.0% and 1.3% at March 31, 2016, 2015 and 2014, 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 long-term senior unsecured rating of A1 from Moody’s Japan K.K., (“Moody’s”), the issuer credit rating of A- from Standard & Poor’s Ratings Japan K.K., (“S&P”) and the foreign and local currency issuer default ratings of A/F1 from Fitch Ratings Japan Limited (“Fitch”). There can be no assurance that these ratings will be maintained.

A material downgrade of our credit ratings may have various effects including, but not limited to, the following:

 

   

we may have to accept less favorable terms in our transactions with counterparties, including capital raising activities, or may be unable to enter into certain transactions;

 

   

foreign regulatory bodies may impose restrictions on our overseas operations;

 

   

existing agreements or transactions may be cancelled; and

 

   

we may be required to provide additional collateral in connection with derivatives transactions.

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, liquidity 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 2014, we and the Bank announced a new medium-term management plan through March 2017. 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 market conditions do not stabilize, market opportunities develop more slowly than expected, our initiatives have less potential than we

 

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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 deterioration 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.

In 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 and regions. 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 results of operations, including impairment losses on goodwill or investments.

Aligned with our business strategies, we have made and may undertake acquisition of a subsidiary, investments in affiliates and other business alliance partners, and reorganization within our Group companies. It is uncertain whether we will receive the expected benefits from those business strategies, due to any adverse regulatory changes, worsening of economic conditions, increased 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 liabilities from the claims related to the businesses prior to our business alliances, and cost from actions by regulatory authorities.

When we acquire a subsidiary, we may recognize 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. Therefore, net losses incurred by equity method investees may cause us to record our share of the net losses. 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. Additionally, we may also incur credit costs from our credit exposure to such partners.

 

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We are exposed to the industry specific risks of the consumer finance industry.

Changes in the legal environment have severely and adversely affected the business performance of consumer lending and credit card companies. We have exposures to the risks specific to the consumer finance industry through our subsidiaries, including Cedyna Financial Corporation (“Cedyna”) and SMBC Consumer Finance Co., Ltd. (“SMBC Consumer Finance”).

Consumer lending and credit card companies had offered unsecured personal loans, which included loans with so-called “gray zone” interest 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, amendments to laws regulating moneylenders, which increased the authority of government regulators, prohibited gray zone interest and introduced an upper limit on aggregate credit extensions to an individual by moneylenders at one-third of the borrower’s annual income, were promulgated in 2006 and became fully effective in June 2010. After the promulgation of such amendments, Cedyna, SMBC Consumer Finance 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, decreased.

In addition, 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 Cedyna, SMBC Consumer Finance 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, and the additional losses could have an adverse effect on our results of operations and financial condition.

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. The deferred tax assets are quantified on the basis of currently enacted tax rates and accounting standards and are subject to change as a result of future changes to tax laws 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 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 other subsidiaries have various defined benefit plans. We have experienced in the past, and may experience in the future, declines in returns on plan assets and changes in the discount rates and other actuarial assumptions. If returns on plan assets decrease, or if we revise the discount rates and other assumptions, the deficit of the impacted defined benefit plan may increase and adversely affect our financial condition and results of operations. Because more than 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. For further information, see Note 23 “Retirement Benefits” to our consolidated financial statements included elsewhere in this annual report.

 

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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, cyber attacks 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, consumer lending, credit card 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 on the Protection of Personal Information, may not be effective in preventing disclosure of personal information 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, misconduct or other unlawful behavior 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, engage in credit card fraud or transfer funds illegally through online banking 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

 

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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 involving Iran and other countries designated by the U.S. Department of State as state sponsors of terrorism or targets 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 Iran, Sudan and Syria. Under U.S. law, there are similar prohibitions or restrictions on dealings with countries, a region and persons 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 Targets”).

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 Targets on a limited basis and in compliance with applicable laws and regulations. These activities include remittance of Japanese yen with respect to our customers’ export or import transactions, maintenance of correspondent banking accounts with Iranian banks, including the Central Bank of Iran, and the payment of fees in Japanese yen to certain Iranian banks in connection with performance bonds issued in the past by the Bank through these Iranian banks related to our customers’ projects in Iran. The performance bonds expired and have not been renewed, but the Bank continues to be obligated to pay certain fees to the Iranian banks. 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 Targets materially affect our business, financial condition or results of operations. A limited number of potential violations of U.S. economic sanctions by the Bank were identified and voluntarily disclosed to OFAC. These transactions resulted from inadvertent operational errors or the lack of familiarity of some personnel of the Bank with the requirements of the relevant regulations in the past, or from the inherent limitation on information about underlying transactions that can be obtained in the course of normal banking operations. 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 voluntarily 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. states 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 engaged in certain 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 recent years, the U.S. government implemented a number of sanctions targeting non-U.S. persons for activities undertaken outside the United States (“secondary sanctions”) that involve specific sanctions targets or certain activities including, among other things, certain transactions related to Iran’s energy, petrochemical, shipping or shipbuilding sectors. Pursuant to the July 14, 2015 Joint Comprehensive Plan of Action (“JCPOA”) agreed to by the five permanent members of the United Nations Security Council plus Germany (the “P5+1”) and

 

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Iran, with the European Union, on January 16, 2016 (“Implementation Day”), the United States lifted U.S. nuclear-related secondary sanctions targeting Iran. Even after Implementation Day, certain secondary sanctions remain in effect, including those targeting significant transactions involving Iranian or Iran-related Specially Designated Nationals and Blocked Persons (“SDNs”). In accordance with applicable laws and regulations, the Bank intends to provide certain services, including settlement services in connection with customers’ trade transactions between Japan and Iran, to the extent that such activities are not targeted by remaining secondary sanctions. For more details of relevant laws and regulations, see “Item 4.B. Business Overview—Regulations in the United States—Laws Prohibiting Money Laundering and Terrorist Financing.”

In addition, the U.S. government has enacted a series of Ukraine-related sanctions, including those under the Ukraine-Related Sanctions Regulations, the Ukraine Freedom Support Act of 2014 and “sectoral” sanctions on the financial, energy and defense sectors of the Russian economy.

The laws, regulations and sanctions referenced above or similar legislative or regulatory developments may further limit our business operations. If we were determined to have engaged in activities targeted by certain U.S. statutes, Executive Orders or regulations, we could lose our ability to open or maintain correspondent or payable-through accounts with U.S. financial institutions, among other potential sanctions. In addition, depending on sociopolitical developments, even though we take measures designed to ensure compliance with applicable laws and regulations, our reputation may suffer due to our association with the Restricted Targets. The above circumstances could have a significant adverse effect on our business or the prices of our securities.

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 certain U.S. sanctions, this could result in the imposition of monetary penalties or other restrictions by the U.S. government against us. Lawsuits and regulatory actions may result in penalties or settlements of very large indeterminate amounts or limit our operations, and costs to defend either could be substantial. Moreover, the Bank and one of its subsidiaries contribute to financial benchmarks such as the Tokyo Interbank Offered Rate (“TIBOR”) and the London Interbank Offered Rate (“LIBOR”) for certain specific currencies. These benchmarks are widely referenced 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, results of operations 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 maintain our lending activities, meet deposit withdrawals, pay our operating expenses and pay interest on and principal of debt and dividends on capital stock. 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 of 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, which could adversely affect our business, results of operations and financial condition.

 

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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 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 results of operations.

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 could adversely affect our capital ratios. In December 2010, the BCBS 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, many of which have been fully applied or phased-in in Japan based on the Basel III implementation schedule.

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 our results of operations and financial condition.

The FSA and regulatory authorities in the United States and other jurisdictions, along with the United Nations, have in recent years made 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, the resolution of failing systemically significant financial institutions, 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, consumer and investor protection, and securitization. Implementation of the Dodd-Frank Act is taking place through detailed rulemaking over multiple years by various regulators.

These and similar, or any other kind of significant regulatory developments could adversely affect our capital ratios and results of operations. For further details, see “Item 4.B. Business Overview—Regulations in

 

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Japan, Regulations in the United States, and Regulations in Other Jurisdictions.” Since those changes in regulation or fiscal or other policies and their effects are unpredictable and beyond our control, we may not be able to comply with those changes at all times, despite 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, results of operations and financial condition.

Changes in the competitive and financial environment and financial systems could have a negative effect on the financial services industry and us.

Deregulation of the financial system, 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:

 

   

banking groups, including Japan’s other major banking groups;

 

   

government-controlled and government-affiliated entities;

 

   

regional banking institutions;

 

   

major investment banks; and

 

   

non-bank financial institutions.

Government measures implemented to stabilize the market and changes in the regulatory framework as well as other government actions may affect our competitive position. The Japan Post Bank Co., Ltd. (“Japan Post Bank”) is a government-controlled entity due to its status as a subsidiary of Japan Post Holdings Co., Ltd. (“Japan Post Holdings”), and one of the world’s largest deposit-taking financial institutions. Under the Postal Privatization Act, Japan Post Bank is required to receive prior approval of the Government of Japan to expand its business until Japan Post Holdings disposes of at least half of the shares of Japan Post Bank. Japan Post Holdings disposed approximately 11% of its shares of Japan Post Bank and Japan Post Bank was listed on the Tokyo Stock Exchange in November 2015, as the first phase of the plan for Japan Post Holdings to gradually dispose of its shares of Japan Post Bank down to around 50% ownership.

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 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.

The changes in the financial environment in Japan may also have a negative effect on the Japanese financial services industry. For example, changes in the monetary policy measures of the Bank of Japan (“BOJ”), including the expansion of the negative interest rate policy, may result in a further decrease in interest rates in Japan. This may lower the domestic interest spreads and significantly affect the businesses of commercial banks in Japan, including us, and have other unforeseen side effects on the functioning of and competition within Japan’s financial markets. For further information on the BOJ’s monetary policy measures, see “Item 5. Operating and Financial Review and Prospects—Overview—Factors Affecting Results of Operation.”

Damage to our reputation may have an adverse effect on our business and results of operations.

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,

 

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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 (“NYSE”)-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 companies listed on a Japanese stock exchange, such as us, to file, together with their annual securities reports required by the FIEA, audited internal control reports assessing the effectiveness of their 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.

Our 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.

 

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Sales of our 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 affect 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:

 

   

the jurisdiction of the foreign court be recognized under laws, regulations, treaties or conventions;

 

   

proper service of process be made on relevant defendants, or relevant defendants be given appropriate protection if such service is not received;

 

   

the judgment and proceedings of the foreign court not be repugnant to public policy as applied in Japan; and

 

   

there exist reciprocity as to the recognition by a court of the relevant foreign jurisdiction of a final judgment of a Japanese court.

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 exercising 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,

 

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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.

 

Item 4. Information on the Company

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.

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.

Information Concerning the Principal Capital Expenditures and Divestitures

On April 1, 2016, Sumitomo Mitsui Finance and Leasing Company, Limited (“SMFL”) acquired General Electric Company (“GE”) group’s leasing business in Japan for ¥181 billion by acquiring a 100% equity interest in GE Japan GK (“GE Japan”). The acquired leasing business is comprised mainly of equipment/asset leasing, small-ticket leasing, and automotive leasing.

Public Takeover Offers

Not applicable.

 

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4.B.     BUSINESS OVERVIEW

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 segment include, in addition to the Bank, SMBC Trust Bank Ltd. (“SMBC Trust Bank”), Kansai Urban Banking Corporation (“KUBC”), THE MINATO BANK, LTD. (“The Minato Bank”), Sumitomo Mitsui Banking Corporation Europe Limited (“SMBC Europe”), and Sumitomo Mitsui Banking Corporation (China) Limited (“SMBC (China)”). Our subsidiaries also include SMFL in our Leasing segment; SMBC Nikko Securities Inc. (“SMBC Nikko Securities”) and SMBC Friend Securities Co., Ltd. (“SMBC Friend Securities”) in our Securities segment; and Sumitomo Mitsui Card Company, Limited (“Sumitomo Mitsui Card”), Cedyna and SMBC Consumer Finance in our Consumer Finance segment. See “Item 4.C. Organizational Structure.”

Management Philosophy

Our Group-wide management philosophy is as follows:

 

   

we grow and prosper together with our customers, by providing services of greater value to them;

 

   

we aim to maximize our shareholders’ value through the continuous growth of our business; and

 

   

we create a work environment that encourages and rewards diligent and highly-motivated employees.

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 employees in the realization of our Group-wide management philosophy in all areas. Our code of conduct is as follows:

 

   

to strive to increase shareholder value whilst also maintaining healthy relationships with customers, employees and other stakeholders. To give utmost consideration to the trust which people have in the Bank, to abide by all laws and regulations, to maintain a high ethical standard, and to act fairly and sincerely;

 

   

to continue improving our knowledge and capability and, at the same time, to raise our productivity in order to provide superior financial services at competitive prices;

 

   

to establish a top brand global bank by understanding the needs of each customer and by providing valuable services which meet those needs;

 

   

to be selective and focused in the implementation of our business strategy, to define and develop the competitive advantages which we have over our competitors and, by allocating managerial resources strategically to those businesses, to become a top player in our selected markets;

 

   

to be creative, proactive and courageous in order to be in a leading position in all business areas and always a step ahead of our competitors;

 

   

to build a strong organization based on market practice and sound principles whilst reflecting our diverse values. To delegate internal authority under an efficient and effective management system which facilitates speedy decision-making and execution; and

 

   

to support the growth of our business by setting challenging targets for our staff and employing results-based evaluation and compensation systems.

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.

 

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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 pollution control with corporate activities, in order to support the economy and contribute to the betterment 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. The Bank and some of our other Group companies adopted “Principles for Financial Action towards a Sustainable Society” in October 2011, which have been set forth for the purposes of making environmental financing widely-known and improving the quality of environmental financing.

The 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 large corporations, mid-sized companies, small-sized companies, individuals, 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 corporate and consumer 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, small-sized companies 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 four business units: the Wholesale Banking Unit, the Retail Banking Unit, the International Banking Unit and the Treasury Unit. In addition to the four business units, the Investment Banking Unit, the Corporate Advisory Division, the Private Advisory Division and the Transaction Business Division of the Bank provide a broad range of financial products, services and solutions to address sophisticated and diverse issues and needs of the Bank’s customers. The Corporate Advisory Division operates within the Wholesale Banking Unit, and the Private Advisory Division operates within the Wholesale Banking Unit and the Retail Banking Unit, while the Transaction Business Division operates within the Wholesale Banking Unit, the Retail Banking Unit and the International Banking Unit. Further, the Bank has the Corporate Staff Unit, the Corporate Services Unit, the Compliance Unit, the Risk Management Unit and the Internal Audit Unit.

The Bank’s Wholesale Banking Unit

The Bank’s Wholesale Banking Unit aims to offer business solutions for the increasingly complex and diverse management issues that are faced by large Japanese corporations, including listed companies and

 

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mid-sized companies, and, together with certain of our Group companies, provides a wide range of financial products and services targeting those corporations and companies, through 178 sales channels of the Bank at March 31, 2016. The financial products and services that this business unit provides include deposits, loans including syndicated loans, commitment lines, structured finance and nonrecourse loans, settlement services, cash management, leasing, factoring, management information systems consulting, collection and investment banking services. This business unit also provides the following products and services:

 

   

Services for Globalizing Corporations. In light of the recent overseas expansion trend, the Bank focuses on offering products and services whereby the Bank assists those customers entering new markets, especially in China and other Asian countries, and accommodates an increase in their international trade operations.

 

   

Loan Products and Services to Promote Socially Responsible Activities. The Bank provides a variety of loan products and services designed for corporate clients engaging in socially responsible activities. These activities include environmentally friendly activities, improvement of eating habits, development of agricultural and fishery industries, and development of risk management systems for emergency situations. The Bank evaluates their socially responsible activities and offers loans with certain conditions incorporating the results of its evaluation. Furthermore, in connection with these loans, the Bank provides advice in relation to the client’s socially responsible initiatives.

 

   

Services to Promote B-to-B Transactions. The Bank, with its subsidiaries and affiliates, provides various internet settlement services to meet its customers’ needs. The Bank has promoted these services to stimulate greater demand for its solutions business. Using these services, corporate customers are able to transfer money more easily and effectively, and also utilize foreign exchange services to transfer funds to and from their overseas counterparts in foreign currencies.

The Bank’s Retail Banking Unit

The Bank’s Retail Banking Unit provides financial services to both consumers residing in Japan and domestic small-sized companies.

For consumers, this business unit offers a wide range of financial services including personal bank accounts, deposit products such as ordinary deposits, time deposits and foreign currency deposits, and the following products and services through various channels:

 

   

Housing Loans. Housing loans, which are principally secured by collateral or supported by guarantees, are one of the primary products offered by this business unit. The Bank provides housing loans with a variety of terms and interest rates, including 2- to 35-year term, fixed-rate loans, to meet diversified customer needs. For instance, the Bank offers a housing loan combined with an insurance policy that covers the repayment of the outstanding loan balance in the event the borrower is diagnosed with certain diseases.

 

   

Investment Trust. The Bank, as a broker, provides a variety of investment trust products with varying risk-return profiles that are developed and managed by experienced asset management companies within Japan and overseas. Also, the Bank, together with its subsidiary SMBC Nikko Securities, offers discretionary investment management services.

 

   

Insurance Products. The Bank, as an agent, offers pension-type insurance, whereby customers who make all premium payments are able to receive annuity payments when they reach a certain age. The Bank, as an agent, also sells a wide range of insurance products, including medical insurance, juvenile insurance, home fire insurance, single-premium whole life insurance and level-premium life insurance.

 

   

Consumer Finance Services. The Bank offers a variety of consumer loan products such as unsecured card loan products to its individual customers.

 

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In addition, the Bank is promoting the collaboration with its subsidiary SMBC Nikko Securities to meet customers’ diverse needs for asset management by leveraging their respective strengths of a broad client base and a high advisory capability.

The operations are mainly conducted through a large and well developed branch network. The Bank had a domestic network consisting of 440 branch offices at March 31, 2016, most of which were located in the Tokyo and Osaka regions. Some branches provide financial consulting services for 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, 2016, the Bank offers its customers’ access to 53,284 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.

This business unit also offers internet banking services for consumers. At March 31, 2016, the Bank’s internet banking services had approximately 14 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.

For small-sized companies, this business unit provides a wide array of financial products and services to comprehensively address in the same place business owners’ needs as both corporate managers and individuals such as business and asset succession.

The Bank also offers wealth management services to its customers in collaboration with SMBC Trust Bank, SMBC Nikko Securities and Barclays PLC (“Barclays”). For further information on alliance with Barclays, see “—Other Major Group Companies and Alliances—Alliance with Barclays PLC.”

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, 2016, the Bank’s international network consisted of 17 branches, 17 sub-branches and 5 representative offices and the Bank seeks to meet customers’ needs globally, together with the network of the Bank’s foreign banking subsidiaries such as SMBC Europe with 7 offices and SMBC (China) with 15 offices, and foreign banking associates including PT Bank Tabungan Pensiunan Nasional Tbk, The Bank of East Asia, Limited, ACLEDA Bank Plc. and Vietnam Export Import Commercial Joint Stock Bank.

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 and Kotak Mahindra Bank Limited. Additionally, in order to further expand our business in the U.S., we and the Bank obtained financial holding company status under the U.S. Bank Holding Company Act of 1956, as amended (“Bank Holding Company Act”), on May 7, 2013, which allows the expansion of the scope of services to provide in the U.S., including underwriting and trading of securities and providing other investment banking services.

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.

 

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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:

 

   

providing a variety of products from traditional money and foreign exchange transactions to derivative transactions; and

 

   

developing channels such as an internet banking site providing foreign exchange transactions to satisfy a variety of requirements and orders from customers.

Others

The Bank also engages in the following business activities through its business units:

 

   

Payment Services. The Bank handles money remittances for municipalities, public and private corporations and individuals in Japan and overseas. Domestic remittance services are significant in Japan, where checks are rarely used and money remittance is a major means of payment. The Bank also handles the collection for its customers of promissory notes, bills of exchange and checks.

 

   

Foreign Exchange. The Bank engages in a variety of foreign exchange transactions, including foreign currency exchange, overseas transfers and trade finance for export and import activities.

The following unit or divisions provide a broad range of financial products, services and solutions to address sophisticated and diverse issues and needs of the Bank’s customers.

 

   

Investment Banking Unit. The Investment Banking Unit provides a broad range of sophisticated financial products and services, as follows:

 

   

Customized Financial Services and Financing Solutions. The Bank provides a wide range of innovative financial services and financing solutions to its corporate clients, including loan syndication, structured finance, project finance, acquisition financing such as LBO and MBO financing, non-recourse real estate finance, securitization, derivatives and M&A advisory.

 

   

Securities Intermediary Services for Corporate Clients. The Bank provides corporate clients with securities intermediary services, and offers structured bonds, subordinated bonds and other products to corporate clients in cooperation with SMBC Nikko Securities.

 

   

Corporate Bond Trust Services. The Bank serves as a trustee or co-trustee of corporate mortgage bonds. The Bank also serves as a commissioned company for bondholders and as a fiscal and paying agent for unsecured bonds that are issued and publicly offered by domestic and foreign customers. In this role, the Bank also advises issuers about market conditions and provides administrative services on behalf of issuers.

 

   

Other Trust Services. The Bank offers other trust services to its customers, including monetary claims trusts for asset securitizations and trusts for structured finance.

 

   

Principal Investments. The Bank, directly or through private equity funds, invests in corporate customers seeking to restructure or reorganize themselves or expand their businesses.

 

   

Solutions Related to Growing Industrial Sectors. The Bank provides a wide range of solutions to corporate customers addressing businesses related to growing industrial sectors, such as environmental, infrastructure, water, new energy, agriculture, health care, and robot industries.

 

   

Corporate Advisory Division. The Corporate Advisory Division complements our service lineup for both listed and non-listed companies, providing financial solutions for the increasingly sophisticated and diverse management issues faced by corporate clients. This division provides a centralized information platform that maintains the Bank’s accumulated information and knowledge concerning a wide range of industries. Leveraging this centralized information platform, this division provides the Bank’s customers with proposals for strategic initiatives to help enhance their corporate value. This

 

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division establishes a separate team for each project and works in cooperation with the Bank’s other departments and our Group companies, including SMFL and SMBC Nikko Securities. This division aims to offer comprehensive solutions for M&A, strategic investment, business alliances and other management issues.

 

   

Private Advisory Division. The Private Advisory Division addresses areas where the needs of individuals and corporate clients overlap, including private banking, corporate employees business, business succession and asset succession consulting for business owners and high-net-worth individuals.

 

   

Transaction Business Division. The Transaction Business Division complements our transaction and financing services, including cash management, settlement, foreign exchange and supply chain finance for our corporate clients. This division aims to offer a variety of products and services to capture customers’ cash flows and business flows.

In addition to the Bank, our domestic banking subsidiaries include SMBC Trust Bank, KUBC and The Minato Bank. SMBC Trust Bank, which became our wholly owned subsidiary in October 2013, offers extensive trust services tailored to the needs of customers, such as wealth management solutions. On November 1, 2015, SMBC Trust Bank acquired the retail banking business of Citibank Japan Ltd. (“Citibank Japan”), a wholly owned subsidiary of Citigroup Inc. Through this acquisition, SMBC Trust Bank is expanding its business model to offer additional products and services to its customers, including foreign currency investment products and global services. KUBC and The Minato Bank are regional financial institutions based in Kansai area and provide commercial banking services to corporations and individuals.

Our domestic banking associate is The Japan Net Bank, Limited (“The Japan Net Bank”), which, as an internet bank, provides internet-based services such as deposits, loans and investment products. The Japan Net Bank, which had been our subsidiary, became our associate in April 2014 due to a decrease in our proportion of voting rights.

Our foreign banking subsidiaries include SMBC Europe, SMBC (China), Manufacturers Bank, Sumitomo Mitsui Banking Corporation of Canada, Banco Sumitomo Mitsui Brasileiro S.A., JSC Sumitomo Mitsui Rus Bank, PT Bank Sumitomo Mitsui Indonesia and Sumitomo Mitsui Banking Corporation Malaysia Berhad.

Our foreign banking associates include PT Bank Tabungan Pensiunan Nasional Tbk, The Bank of East Asia, Limited, one of the largest commercial banks in Hong Kong, which became our associate in March 2015, ACLEDA Bank Plc., the largest bank in Cambodia, which became our associate in September 2015, and Vietnam Export Import Commercial Joint Stock Bank.

Leasing

Sumitomo Mitsui Finance and Leasing Company, Limited

Sumitomo Mitsui Finance and Leasing Company, Limited (“SMFL”), one of the major leasing companies in Japan, provides a variety of leasing services including equipment, operating, leveraged and aircraft leasing. The aircraft leasing business was integrated into SMBC Aviation Capital, a subsidiary of SMFL, in 2013. We have a 60% equity interest in SMFL, while the remaining 40% is held by Sumitomo Corporation, a non-affiliate.

On April 1, 2016, SMFL acquired GE group’s leasing business in Japan by acquiring a 100% equity interest in GE Japan. The acquired leasing business is comprised mainly of equipment/asset leasing, small-ticket leasing, and automotive leasing. Through this acquisition, we aim to upgrade the marketing strategies and sales capabilities by leveraging GE Japan’s know-how developed under GE, and offer a wide range of financial solutions by enhancing the combined client base of SMFL and GE Japan.

 

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Others

In addition to the above companies, our U.S. subsidiary SMBC Leasing and Finance, Inc. engages in the leasing business. Our associate Sumitomo Mitsui Auto Service Company, Limited engages in the auto leasing business.

Securities

SMBC Nikko Securities Inc.

As one of the major Japanese securities companies, SMBC Nikko Securities Inc. (“SMBC Nikko Securities”), our wholly owned subsidiary, 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 123 branches nationwide at March 31, 2016, 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.

SMBC Nikko Securities, together with its overseas network, SMBC Nikko Securities (Hong Kong) Limited, SMBC Nikko Securities (Singapore) Pte. Ltd., SMBC Nikko Capital Markets Limited and SMBC Nikko Securities America, Inc. (“SMBC Nikko Securities America”), 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.

SMBC Friend Securities Co., Ltd.

SMBC Friend Securities Co., Ltd. (“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.

On May 12, 2016, we announced our plan to merge SMBC Nikko Securities and SMBC Friend Securities in January 2018. We expect the merger will strengthen our securities business by reinforcing consulting type sales, enhancing productivity through the optimization of sales personnel staffing, and achieving cost saving synergies resulting from the consolidation of overlapping management infrastructure.

Business Alliance with Citigroup Inc.

In May 2009, we entered into a strategic business alliance with Citigroup Inc. (“Citigroup”) centering on a variety of collaborative activities between SMBC Nikko Securities and Citigroup. As part of this alliance, Citigroup provides 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 Inc. in the origination and distribution of financial products in Japan and globally is being upheld with SMBC Nikko Securities.

Consumer Finance

Sumitomo Mitsui Card Company, Limited

Sumitomo Mitsui Card Company, Limited (“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.

 

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We, Sumitomo Mitsui Card, the Bank and NTT DoCoMo, Inc. (“NTT DoCoMo”) formed a strategic business and capital alliance in credit payment service. We have a 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.

In 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 from 2005, with China UnionPay Co., Ltd., a bankcard association in China.

Cedyna Financial Corporation

Cedyna Financial Corporation (“Cedyna”), our wholly owned subsidiary, conducts credit card, installment (such as shopping credit and automobile loan) and solution (such as collection outsourcing and factoring) businesses.

In April 2014, Cedyna transferred its own collection outsourcing business to SMBC Finance Service Co., Ltd., its wholly owned subsidiary that provides collection outsourcing services and has strong customer base and internet settlement know-how, in order to strengthen its competitive edge by taking advantage of scale and promoting streamlining.

SMBC Consumer Finance Co., Ltd.

SMBC Consumer Finance Co., Ltd. (“SMBC Consumer Finance”), our wholly owned subsidiary, is a core entity in our consumer lending business. It provides consumer loans, together with its wholly owned subsidiary Mobit Co., LTD., 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.

Others

In addition to the above companies, our subsidiary Sakura Card Co., Ltd., which was merged into Cedyna on April 1, 2016, and our associate Pocket Card Co., Ltd. engage in the credit card business, and our subsidiary SMM Auto Finance, Inc. engages in automobile sale financing.

Other Major Group Companies and Alliances

The Japan Research Institute, Limited

The Japan Research Institute, Limited (“The Japan Research Institute”) 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.

Alliance with Barclays PLC

Barclays PLC (“Barclays”) and the Bank have allied to explore joint business development opportunities, and 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.

 

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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 (“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 drawdowns under the FLC in accordance with its terms.

In 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:

 

   

Goldman Sachs may make credit commitments covered by the arrangements only to borrowers approved by the Bank.

 

   

Unless the Bank and Goldman Sachs agree otherwise, the borrowers covered by the FLC and any SLC Series that are rated by both of the two major rating agencies must be rated investment grade by at least one, and borrowers that are rated only by one of the two major rating agencies must be rated investment grade by that rating agency. If neither of the two major rating agencies rates a borrower, then further credit to the borrower shall no longer be covered by the FLC or any SLC Series, if the Bank and Goldman Sachs determine the borrower’s credit conditions are lower than investment grade.

 

   

If the ratings of an approved borrower fall below investment grade in the judgment of both major rating agencies (or, if a borrower is rated investment grade by only one agency, and that agency downgrades the borrower below investment grade), further credit to that borrower will no longer be covered by these arrangements, unless the Bank and Goldman Sachs otherwise agree.

 

   

On the fifth, tenth and fifteenth anniversaries of the transaction, the Bank has the right to cause Goldman Sachs to stop extending new credit to borrowers the Bank deems to have become “unbankable.” Unbankable borrowers are those who have investment grade ratings from the two major rating agencies but are deemed by the Bank to be below BB- and below Ba3 based on the Bank’s application of rating agency methodologies and criteria. If Goldman Sachs disagrees with the Bank, the matter is to be referred to arbitration, and a suspension is effective unless and until an arbitrator rules in favor of Goldman Sachs.

 

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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 $1.723 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 Islands 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 Islands 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.

Management Policies

With the completion of the previous medium-term management plan for the three years through March 31, 2014, the management objectives of which were to aim for top quality in strategic business areas and to establish a solid financial base and corporate infrastructure to meet the challenges of financial regulations and the highly competitive environment, we and the Bank announced in May 2014 our vision for the next decade and the new management goals for the three-year medium-term management plan through March 2017.

Vision for the Next Decade

Our vision for the next decade, in view of the changing business environment, including the growth of Asia’s emerging countries, the aging and shrinking Japanese population and global financial regulatory reform, is to become a global financial group that, by earning the highest trust of our customers, lead the growth of Japan and the Asian region. Specifically, we aim to achieve the following three points.

We aim to become a truly Asia-centric institution. Strengthening our business in Asia is the key strategy for realizing our vision in view of the high medium- to long-term growth potential of Asia’s emerging countries. We will proactively invest our resources in the region in order to become a leading financial group in Asia.

We aim to develop the best-in-class earnings base in Japan. Japan is a mature market but there are opportunities within the market segments and we aim to proactively contribute to the revitalization of the Japanese economy by investing our resources in such growth areas and taking appropriate risks. At the same time, we intend to capture a high market share and build a solid earnings base by implementing specific strategies for enhancing our capability to meet our clients’ needs.

 

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We aim to realize true globalization and continue to evolve our business model. We intend to expand our global franchise and implement measures to realize the true globalization of our corporate infrastructure that supports our growth. At the same time, we intend to continue to evolve our business model by anticipating changes in our business environment, both domestic and international.

Three-Year Management Goals

In the three years ending March 2017, we aim to further evolve our client-centric business models, revise our portfolio structure, and enhance our client base with speed in order to achieve the sustainable growth of our top-line profit and further increase our enterprise value. We also set the following four goals for our three-year medium-term management plan as the first step toward realizing our vision.

Develop and evolve client-centric business models for main domestic and international businesses. The needs of our clients are becoming more diverse and sophisticated, and we are implementing a number of initiatives to meet their needs. We have revised our client segmentation and are implementing strategies and evolving business models accordingly, and allocating resources from the perspective of group optimization.

 

   

Large corporate business strategy. The activities of our large corporate clients are becoming more global, and cross-border, and accordingly, their financial needs are becoming bigger and more complex. We are creating a unique business model, Global-Corporate and Investment Banking (“G-CIB”) model, to meet their needs, thereby enhancing our client base and top-line profit.

 

   

Middle market and small and medium-sized enterprise business strategy. In the middle and small and medium-sized enterprise markets, where we have a number of strengths, we have revised the client segmentation and grouped clients based on attributes in order to fully meet the financial needs of each individual company. Further, under the newly launched Area system, we aim to comprehensively address needs of business owners both as corporate managers and as individuals, through one-stop-services.

 

   

Consumer banking business strategy. The financial needs of individuals are changing, under the circumstances of the accelerated shift from savings to investment, the arrival of the great era of inheritance, and changing lifestyles. We intend to meet their needs by implementing strategies based on a new client segmentation on a Group-wide basis and achieve the top business base in Japan.

 

   

Consumer finance and credit card business strategy. In the consumer finance business, we aim to expand the variety of our client base and achieve an overwhelming share in the domestic market through the integrated operation of the planning and promotion functions of SMBC and SMBC Consumer Finance. In the credit card business, we intend to reinforce our top-line profit by leveraging the strengths of Sumitomo Mitsui Card and Cedyna as bank-based and retail-based credit card companies, respectively. At the same time, we intend to pursue cost synergies by managing the business on a group basis through measures such as integrating the management platforms of the Group’s credit card companies.

 

   

International business strategy. In our international business, we intend to shift our business model in order to achieve sustainable growth by improving the efficiency of assets while depending less on lending volume. At the same time, we intend to enhance our global franchise. Specifically, we aim to strengthen multi-faceted transactions with globally operating non-Japanese corporate clients. To this end, we are enhancing our product line-up and promoting cross-selling by strengthening the transaction banking business, and revising our client coverage to a more global-based framework. Further, we will create a highly profitable asset portfolio by diversifying and flexibly rebalancing our portfolio.

 

   

Institutional investor business strategy. We intend to create a new business model to meet the needs of institutional investors by establishing a Group-wide framework, centered on the Bank and SMBC Nikko Securities, enhancing our ability to provide products to institutional investors and strengthening our capability to source, underwrite and distribute deals domestically and internationally.

 

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IT and transaction banking business strategy. Information and communication technology (“ICT”) and transaction banking business are necessary underpinnings for creating new businesses, and we intend to offer new leading-edge services through various measures, including alliances with leading players in ICT.

Build a platform for realizing Asia-centric operations and capture growth opportunities. We aim to become a global financial group that, by earning the highest trust of our customers, leads the growth of Japan and the Asian region. This is our vision for the next decade and, to this end, we aim to steadily create a business platform in Asia, with the enhancement of our Asia business as the principal strategy for the whole group, and prioritize the allocation of resources, including human resources and infrastructure, to Asia.

Realize sustainable growth of top-line profit while maintaining soundness and profitability. Underpinned by the stable financial base built during the previous years, we intend to focus more on growth in the three-year medium-term management plan. We intend to achieve sustainable growth of our top-line profit by developing and evolving our business models and allocating resources to growth fields while continuing to focus on maintaining soundness and profitability.

Upgrade corporate infrastructure to support our next stage of growth. Our business is expanding globally and on a Group-wide basis, and we intend to strengthen our management platform to support our business growth. Specifically, we intend to globalize our organization and human resources and intensify group management. To this end, we recently established “Global Human Resources Department.” We also recently established “Diversity and Inclusion Committee” to promote diversity as we believe diversity is a source of competitiveness. We are also upgrading our risk management system.

Our basic policies for the fiscal year ending March 31, 2017, the final year of the three-year medium-term management plan, are as follows: “focus on bottom-line profit by strengthening efforts to improve profitability and efficiency, while maximizing efforts to realize the key initiatives set in the medium-term management plan and grow our top line profit” and “run a strict risk-sensitive operation given the current uncertain business environment, while pursuing new business opportunities by responding to changes in a proactive and innovative manner.”

Revenues by Region

The following table sets forth the percentage of our total operating income under IFRS for the fiscal years ended March 31, 2016, 2015, and 2014, based on the total operating income of our offices in the indicated regions. For each of the periods presented, we earned three-quarters of our total operating income in Japan, where we compete with other major Japanese banking groups and financial service providers. We earned the remainder in the Americas, Europe and Middle East, and Asia and Oceania, where we mainly compete with global financial institutions.

 

     For the fiscal year ended March 31,  
     2016     2015     2014  

Region:

      

Japan

     77     76     78

Foreign:

      

Americas

     5     5     6

Europe and Middle East

     10     11     9

Asia and Oceania (excluding Japan)

     8     8     7
  

 

 

   

 

 

   

 

 

 

Total

     100     100     100
  

 

 

   

 

 

   

 

 

 

 

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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

See “—Description of Operations and Principal Activities” for a discussion of our marketing channels.

Regulations in Japan

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. On the other hand, deregulation of banking activities in Japan, and more generally of the Japanese financial system, has proceeded, which has made the Japanese banking industry highly competitive.

Supervisory and regulatory authorities

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 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 of Japan

The Prime Minister has supervisory authority over banks in Japan, which is generally delegated to the Financial Services Agency of Japan (“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 granting and revoking of operating licenses, and approving business activities such as becoming a principal shareholder, establishment of subsidiaries or overseas offices, mergers, corporate splits or business transfers, and dissolutions or discontinuations of business by existing banks, etc.

The 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 difficulty to take certain actions, such as holding certain property in Japan for the protection of depositors. Under the prompt corrective action (“PCA”) system, the FSA may take corrective actions in the case of capital deterioration of financial institutions.

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, such as bank holding company regulations, single customer credit limits, disclosure regulations, regulations regarding reserves for loan losses and inspections.

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

 

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FSA monitors the financial soundness of banks and the status and performance of their control systems and reviews their compliance with laws and regulations. The FSA has issued guidelines on its inspection of financial institutions called the Financial Inspection Manual. The Financial Inspection Manual itself does not have the force of law, but the FSA’s inspections of banks are based on 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. Following an inspection, the FSA may exercise its authority over a bank under the Banking Act to suspend or terminate its banking business.

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 Bank of Japan (“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 operations 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, most 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.

Regulations Regarding Capital Adequacy and Liquidity

Capital Adequacy Requirement

In 1988, the BCBS issued the Basel Capital Accord. 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 was 8% on both a consolidated and nonconsolidated basis. In 2004, the BCBS 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 July 2009, the BCBS 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 (the “GHOS”) reached an agreement on several key measures to strengthen regulation of the banking sector, and in December 2009 the BCBS published a consultative document entitled “Strengthening the resilience of the banking sector” containing proposals on these measures centering on several core areas. The BCBS’ 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 1 capital must be common shares and retained earnings; limitations on the use of hybrid instruments with an incentive to redeem; a requirement that regulatory adjustments, 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.

 

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The BCBS’ proposals also cover the following key areas:

 

   

strengthening the risk coverage of the capital framework;

 

   

introducing a leverage ratio as a supplementary measure to the Basel II risk-based framework with a view to migrating to a Pillar 1 (minimum capital requirement) treatment based on appropriate review and calibration (for further information, see “Leverage Ratio” below);

 

   

introducing measures to promote the build-up of capital buffers in good times that can be drawn upon in periods of stress; and

 

   

introducing minimum liquidity standards for internationally active banks that include a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio (for further information, see “Liquidity Requirement” below).

In July 2010, the GHOS reached a broad agreement on the overall design of the BCBS’ capital and liquidity reform package. In addition, in August 2010, the BCBS issued for consultation a proposal to enhance the loss absorbency function of regulatory capital. In September 2010, the GHOS 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 increased the minimum common equity requirement from 2% to 4.5% and will 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 1 capital requirement also increased from 4% to 6% (increasing to 8.5% when included together with the above capital conservation buffer). The total capital requirement remains at 8% but will increase to 10.5% with the capital conservation buffer by January 2019. In addition, a countercyclical buffer within a range of 0% to 2.5% of common equity or other fully loss-absorbing capital has been implemented according to national circumstances. The GHOS also agreed on transitional arrangements for implementing the new standards. Under the transitional arrangements, these new capital requirements are being phased in between January 1, 2013 and January 1, 2019. In December 2010, the BCBS published the new Basel III rules text. To reflect changes made by the BCBS, the FSA changed its capital adequacy guidelines. The FSA’s changes have mostly been applied from March 31, 2013, which generally reflect the main measures of the minimum capital requirements of the BCBS that started to be phased in on January 1, 2013 and will be fully applied from March 2019. The FSA’s changes which reflect capital buffer requirements under Basel III and the G-SIFI capital surcharge described below have been applied from March 31, 2016.

In September 2013, the BCBS and the International Organization of Securities Commissions (“IOSCO”) released the final framework for margin requirements for non-centrally cleared derivatives (“2013 framework”). This framework will require high quality liquid assets to be posted as margin on non-centrally cleared derivative transactions, which could adversely affect our liquidity position. The requirements were originally planned to be phased in over a four-year period beginning in December 2015 with the largest, most active and most systemically important participants in the derivatives market, including us. In March 2015, the BCBS and IOSCO released revisions to the 2013 framework, which delay the beginning of the phase-in period for collecting and posting initial margin on non-centrally cleared trades from December 2015 to September 2016. The full phase-in schedule has been adjusted to reflect this nine-month delay. The revisions also institute a six-month phase-in period of the requirement to exchange variation margin, beginning in September 2016.

In addition to the above-mentioned minimum capital requirements and capital buffer requirements under Basel III, organizations identified by the FSB as G-SIFIs, which as of November 2014 and 2015 included us, are required to maintain an additional 1% to 2.5% of common equity as a percentage of risk-weighted assets based on the organization’s size, interconnectedness, substitutability, complexity and cross-jurisdictional activity as determined by the FSB. This requirement is commonly referred to as the G-SIFI capital surcharge. The G-SIFI capital surcharge requirement is being phased in from January 2016 to January 2019. The amount of G-SIFI capital surcharge that applies to us based on the FSB’s determination as of November 2014 and 2015 will be 1% of risk-weighted assets when the requirement is fully applied from 2019. The FSB updates its list of G-SIFIs on an annual basis.

 

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G-SIFIs will also be subject to a global standard for TLAC, which establishes a minimum requirement for loss-absorbing and recapitalization capacity available in resolution at G-SIFIs, to ensure that they can be resolved in an orderly manner without putting public funds at risk. In November 2015, as part of its agenda to address risks arising from G-SIFIs, the FSB published the final TLAC standard. The final TLAC standard defines certain minimum requirements for instruments and liabilities so that if a G-SIFI fails, it will have sufficient loss-absorbing and recapitalization capacity available to ensure that it can be resolved in an orderly manner which minimizes potential impact on financial stability, maintains the continuity of critical functions and avoids exposing public funds to loss. In addition, in April 2016, the FSA published a paper entitled “The FSA’s Approach to Introduce the TLAC Framework” (“FSA’s Approach”) which describes the FSA’s approach for the introduction of TLAC requirements in Japan, although it remains subject to change based on future international discussions. According to the FSA’s Approach, the preferred resolution strategy for G-SIFIs in Japan is Single Point of Entry resolution, in which resolution powers are applied to the top-level entity of a banking group by a single national resolution authority, although the actual measures to be taken will be determined on a case-by-case basis considering the actual condition of the relevant Japanese G-SIFI in crisis. To implement this Single Point of Entry resolution strategy effectively, the FSA plans to require bank holding companies of Japanese G-SIFIs, which will be the resolution entities, to (i) meet the minimum external TLAC requirements provided under the FSB’s TLAC standard (being at least 16% of their risk-weighted assets starting from March 2019 and at least 18% of their risk-weighted assets starting from March 2022), and (ii) cause their material subsidiaries that are designated as systemically important by the FSA, including but not limited to certain material sub-groups as provided in the FSB’s TLAC standard, to maintain a certain level of capital and debt recognized by the FSA as internal TLAC, in order that losses incurred at the material sub-group can be absorbed by the bank holding company through such internal TLAC with the involvement of the FSA. In addition, according to the FSA’s Approach, Japanese G-SIFIs are expected to be allowed to count the Japan’s deposit insurance fund reserves in an amount equivalent to 2.5% of their risk-weighted assets from March 2019 and 3.5% of their risk-weighted assets from March 2022 as external TLAC.

The final TLAC standard also prescribes a minimum TLAC requirement of at least 6% of the resolution group’s Basel III leverage ratio denominator starting from March 2019, increasing to at least 6.75% starting from March 2022, and according to the FSA’s Approach, the same external TLAC requirements on the leverage ratio basis are planned to be required for bank holding companies of Japanese G-SIFIs. The leverage ratio-based minimum TLAC requirement does not require application of any capital buffers. As a G-SIFI, we will be subject to the final TLAC standard, as implemented in Japan.

Furthermore, as a disincentive for G-SIFIs facing the maximum G-SIFI capital surcharge to “increase materially their global systemic importance in the future,” an additional 1% capital surcharge could be applied. So long as we are identified as a G-SIFI, we are also 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.

Because we have been identified as a G-SIFI, we are also subject to, among other things, 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 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. Under the Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc., issued by the FSA, as part of crisis management, financial institutions identified as G-SIFIs must prepare and submit a recovery plan, which includes a description of events that would trigger implementation of the recovery plan and the analysis of the recovery options to the FSA, and the FSA must prepare the resolution plan for each G-SIFI.

 

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In December 2014, the BCBS published a consultative document on the design of a capital floor framework which will replace the current transitional floor based on the Basel I standard with a capital floor based on the Basel II/III standard. The proposed framework will be based on the finalized version of the standardized approach, which is also being revised. The GHOS is planning to review the BCBS’ proposals on the design and calibration of capital floors at or around the end of 2016.

In April 2016, the BCBS issued standards for interest rate risk in the banking book (“IRRBB”) which adopts an enhanced Pillar 2 approach for IRRBB. The standards revise the BCBS’ guidance set out in its 2004 Principles for the management and supervision of interest rate risk, which lays out the BCBS’ expectations for banks’ identification, measurement, monitoring and control of IRRBB as well as the banks’ supervision, to reflect changes in market and supervisory practices since the principles were first published in 2004. The revised standards are expected to be implemented by 2018.

Our 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. This requirement on a consolidated basis is applied in addition to and in a manner similar to the requirements on a nonconsolidated basis referred to above. These amendments became effective from April 2011.

Leverage Ratio

In March 2015, the FSA published its leverage ratio guidelines which have been applied from March 31, 2015 to help ensure broad and adequate capture of both on- and off-balance sheet sources of leverage for internationally active banks. The FSA’s leverage ratio guidelines are based on the text of the leverage ratio framework and disclosure requirements issued by the BCBS in January 2014. Any final adjustments to the definition and calibration of the leverage ratio were scheduled to be made by the BCBS by 2017, with a view to migrate to a Pillar 1 treatment on January 1, 2018, based on appropriate review and calibration.

In January 2016, the GHOS agreed that the leverage ratio should be based on a Tier 1 definition of capital and should comprise a minimum level of 3%, and the GHOS discussed additional requirements for G-SIFIs. The GHOS is planning to finalize the calibration in 2016 to allow sufficient time for the leverage ratio to be implemented as a Pillar 1 measure by January 1, 2018.

 

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Liquidity Requirement

In October 2014, the FSA published its guidelines for liquidity coverage ratio (“LCR”) applicable to banks with international operations that have been applied from March 31, 2015. These guidelines are based on the full text of the LCR standard issued by the BCBS in January 2013. LCR is intended to promote resilience to potential liquidity disruptions over a thirty-day horizon and help ensure that global banks have sufficient, unencumbered, high-quality liquid assets to offset the net cash outflows they could encounter under an acute short-term stress scenario. Under the FSA’s LCR guidelines, banks with international operations must maintain LCR of 100% on both a consolidated basis and a nonconsolidated basis, while the minimum LCR requirements are being phased in between March 31, 2015 and March 31, 2019 with an increase of 10% in each year starting from 60%.

In October 2014, the BCBS issued the final standard for the net stable funding ratio (“NSFR”), which requires a minimum amount of stable sources of funding at a bank relative to the liquidity profiles of the bank’s assets, as well as the potential for contingent liquidity needs arising from off-balance sheet commitments, over a one-year horizon. NSFR is scheduled to be introduced as a minimum standard by January 1, 2018.

Self-Assessment, Reserves and Related Disclosure

Financial institutions, including the Bank, are required to establish self-assessment programs to, among other things, 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.

Based on the results of the self-assessment discussed above, the Bank is required to establish a reserve for its loan portfolio in an amount the Bank considers adequate at a balance sheet date. Three categories of reserves the Bank establishes, for statutory purposes, along with the Accounting Standards for Banks issued by the Japanese Bankers Association, are a general reserve, a specific reserve and a reserve for specific overseas loan losses.

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 to the FSA annual reports 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,

 

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(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 assets 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.

Prompt Corrective Action System

Under the Prompt Corrective Action (“PCA”) system, the FSA may take corrective actions depending upon the extent of capital deterioration of a financial institution. The FSA may require a bank to submit and implement a capital reform plan, if;

 

   

the total risk-weighted capital ratio of a bank with international operations becomes less than 8% but not less than 4%;

 

   

the Common Equity Tier 1 risk-weighted capital ratio becomes less than 4.5% but not less than 2.25%; or

 

   

the Tier 1 risk-weighted capital ratio becomes less than 6% but not less than 3%.

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 in 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 total risk-weighted capital ratio of a bank with international operations declines to less than 4% but not less than 2%;

 

   

the Common Equity Tier 1 risk-weighted capital ratio becomes less than 2.25% but not less than 1.13%; or

 

   

the Tier 1 risk-weighted capital ratio becomes less than 3% but not less than 1.5%.

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 total risk-weighted capital ratio of a bank with international operations declines to less than 2% but not less than 0%;

 

   

the Common Equity Tier 1 risk-weighted capital ratio becomes less than 1.13% but not less than 0%; or

 

   

the Tier 1 risk-weighted capital ratio becomes less than 1.5% but not less than 0%.

The FSA may order the bank to suspend all or part of its business, if the total risk-weighted capital ratio, the Common Equity Tier 1 risk-weighted capital ratio or Tier 1 risk-weighted capital ratio of a bank with international operations declines below 0%.

The FSA may take actions similar to the actions the FSA may take with respect to a bank, if;

 

   

the total risk-weighted capital ratio of a bank holding company that holds a bank with international operations declines to levels below 8%;

 

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the Common Equity Tier 1 risk-weighted capital ratio declines to levels below 4.5%; or

 

   

the Tier 1 risk-weighted capital ratio declines to levels below 6%.

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.

Restrictions on Capital Distributions

Under the FSA’s capital adequacy guidelines and related ordinances, if a bank fails to maintain capital levels under the capital buffer requirements in accordance with Basel III and the G-SIFI capital surcharge, the FSA may order a bank to submit and implement a reasonable capital distribution constraint plan to restore the capital levels. This plan shall include restrictions on capital distributions, such as dividends, share buybacks, discretionary payments on other Tier 1 capital instruments and bonuses, in such amount as determined depending on the degree of insufficiency of such requirements.

Regulations for Stabilizing the Financial System

Deposit Insurance System

The Deposit Insurance Act was enacted to protect depositors when deposit-taking institutions fail to meet their obligations. The Deposit Insurance Corporation of Japan (“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.

From April 2011 to March 2014, the DIC received annual insurance premiums from member deposit-taking financial institutions, amounting 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 0.082% of other deposits. From April 2014, they amounted to 0.108% and 0.081%, respectively. For the fiscal years ended March 31, 2013 through 2015, a certain amount was reimbursed to the member institutions each fiscal year because there were no failures of insured deposit-taking financial institutions. From April 2015, annual insurance premiums amounted to 0.054% of deposits primarily for payment and settlement purposes and 0.041% of deposits for other deposits.

Premiums held by the DIC may be either deposited at deposit-taking 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.

The Deposit Insurance Act also provides a permanent system for resolving failed deposit-taking institutions.

 

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The basic method for resolving a failed deposit-taking 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 deposit-taking 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 affect a prompt transfer of business, the following framework has been established:

 

   

a Financial Reorganization Administrator is appointed by the FSA Commissioner and takes control of the management and assets of the failed deposit-taking institution. The administrator is expected to diligently search for a deposit-taking institution which will succeed to the business of the failed institution;

 

   

if no successor deposit-taking institution can be immediately found, a “bridge bank” will be established by the DIC for the purpose of temporarily maintaining the operations of the failed deposit-taking institution, and the bridge bank will seek to transfer the failed deposit-taking institution’s assets to another deposit-taking institution or dissolve the failed deposit-taking institution; and

 

   

in order to facilitate or encourage a deposit-taking institution to succeed to a failed business, financial aid may be provided by the DIC to any successor deposit-taking institution to enhance its capital after succession or to indemnify it for losses incurred as a result of the succession.

Where it is anticipated that the failure of a deposit-taking institution may cause an extremely grave problem in maintaining the financial order in Japan or the region where the deposit-taking institution is operating, the following exceptional measures may be taken following deliberation by Japan’s Financial Crisis Response Council:

 

   

the DIC may subscribe for shares or other instruments issued by the relevant deposit-taking institution or the holding company thereof and require the institution to submit to the DIC a plan to reestablish sound management (Item 1 measures) (dai ichigo sochi);

 

   

once the deposit-taking institution fails, financial aid exceeding the cost of pay-off may be available to the institution (Item 2 measures) (dai nigo sochi); and

 

   

if the failed institution is a bank and the problem cannot be avoided by other measures, then the DIC may acquire all of the shares of the bank (Item 3 measures) (dai sango sochi).

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 of Japan.

In addition, on June 12, 2013, a bill to amend the Deposit Insurance Act which includes establishment of a new orderly resolution regime of financial institutions was enacted and became effective on March 6, 2014. Financial institutions including banks, securities companies and insurance companies and their holding companies will be subject to the new resolution regime that includes, among others, the following features.

Under the new resolution regime, where the Prime Minister recognizes that the failure of a financial institution which falls into either of (a) or (b) below may cause significant disruption in the financial markets or other financial systems in Japan if measures described in (a) (specified Item 1 measures) (tokutei dai ichigo sochi) or measures described in (b) (specified Item 2 measures) (tokutei dai nigo sochi) are not taken, the Prime Minister may confirm that any of the following measures need to be applied to the financial institution following deliberation by Japan’s Financial Crisis Response Council:

(a) if the financial institution is not a financial institution whose liabilities exceed its assets, which means it is unable to fully perform its obligations with its assets, the DIC shall supervise the operation of business and management and disposal of assets of that financial institution, and may provide it with loans or guarantees necessary to avoid the risk of significant disruption in the financial systems in Japan, or subscribe for shares or subordinated bonds of, or lend subordinated loans to, the financial institution, taking into consideration the financial condition of the financial institution;

 

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(b) if the financial institution is a financial institution whose liabilities exceed or are likely to exceed its assets or which has suspended or is likely to suspend payment of its obligations, the DIC shall supervise the operation of business and management and disposal of assets of that financial institution and may provide financial aid necessary to assist a merger, business transfer, corporate split or other reorganization in respect to such failed financial institution; and

if a measure set out in (b) above is determined to be taken with respect to a financial institution, the Prime Minister may order that the financial institution’s operations of business and management and disposal of assets be placed under the special control of the DIC. The business or liabilities of the financial institution subject to the special supervision by the DIC as set forth above may also be transferred to a “bridge bank” established by the DIC for the purpose of the temporary maintenance and continuation of operations of, or repayment of the liabilities of, such financial institution, and the bridge bank will seek to transfer the financial institution’s business or liabilities to another financial institution or dissolve the financial institution. The financial aid provided by the DIC to assist a merger, business transfer, corporate split or other reorganization in respect to the financial institution set out in (b) above may take the form of a monetary grant, loan or deposit of funds, purchase of assets, guarantee or assumption of debts, subscription of preferred stock or subordinated bonds, subordinated loan, or loss sharing.

The expenses for implementation of the measures for these crisis management operations will be borne by the financial industry; provided, however, the Government of Japan may provide subsidies to the DIC within the limit to be specified in the government budget in cases where it is likely to cause extremely serious hindrance to the maintenance of the credit system in Japan or significant turmoil in the financial market or other financial system of Japan if such expenses are to be borne only by the financial industry.

On March 6, 2014, the FSA made an announcement clarifying the requirement of loss absorbency at the point of non-viability for additional Tier 1 instruments and Tier 2 instruments under Basel III issued by banks and bank holding companies. According to the announcement, (i) additional Tier 1 instruments and Tier 2 instruments under Basel III issued by a bank must be written-down or converted into common shares when the Prime Minister of Japan confirms (nintei) that the above-described “Item 2 measures (dai nigo sochi),” “Item 3 measures (dai sango sochi),” or “specified Item 2 measures (tokutei dai nigo sochi)” need to be applied to the bank and (ii) additional Tier 1 instruments and Tier 2 instruments under Basel III issued by a bank holding company must be written-down or converted into common shares when the Prime Minister of Japan confirms (nintei) that the above-described “specified Item 2 measures (tokutei dai nigo sochi)” need to be applied to the bank holding company. The FSA also stated in the announcement that the trigger event for loss absorbency at the point of non-viability with respect to such instruments should be construed in accordance with the then effective financial crisis response framework for banks and bank holding companies that have failed or are likely to fail, since the purpose of such write-down or conversion required under Basel III is to ensure that all classes of these capital instruments fully absorb losses at the point of non-viability before taxpayers are exposed to loss.

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 deposit-taking 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 deposit-taking institution by a deposit-taking institution that is made in accordance with a management base-strengthening plan that has been approved by the Government of Japan.

Single Customer Credit Limit

The Banking Act restricts the aggregate amount of credit and loans that may be extended to any single customer in order to avoid the excessive concentration of credit risks and promote the fair and extensive use of

 

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bank credit. To tighten the restrictions under Japanese law to meet international standards, the Banking Act and the related cabinet order were amended in June 2013 and October 2014, respectively and those amendments became effective in December 2014. As a result of the amendments, the credit limit of bank holding companies, banks or bank groups for any single customer, including certain of the customer’s affiliates, was lowered from 40% to 25% of the total qualifying capital of the bank holding company, bank or bank group, with certain adjustments.

Restrictions on Activities of a Bank Holding Company

Under the Banking Act, 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.

An amendment to the Banking Act was promulgated in June 2016. Among other things, the amendment (1) requires a bank holding company to enhance group management, by measures including establishment of a basic policy of such group, coordination of conflicts of interest among group companies, development of a group compliance system and others; (2) permits a bank holding company or a group company, with prior approval of the Government of Japan, to manage certain businesses of other group companies that are common and duplicative; and (3) permits a bank or a bank holding company, with prior approval of the government, to hold voting rights of companies conducting businesses that contribute to or are expected to contribute to the sophistication of the banking business or the enhancement of customer convenience by utilizing information technology or other technologies, regardless of the shareholding restriction described below. The amendment is scheduled to become effective by June 2017.

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 1 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. In order 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, share purchases by the Banks’ Shareholdings Purchase Corporation of listed shares have been restarted from March 2009.

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.

 

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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.

Furthermore, 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.

Regulations for Protection of Customers

Protection of Personal Information

The Act on the 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 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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Act on Prevention of Transfer of Criminal Proceeds

Under the Act on Prevention of Transfer of Criminal Proceeds, 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.

Other Regulations Related to Our Business

Financial Instruments and Exchange Act of Japan

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.

An amendment to the FIEA was promulgated in September 2012 in order to, among other things, facilitate the establishment of a “Comprehensive Exchange,” in which securities, financial derivatives and commodity derivatives are traded comprehensively. It enables Financial Instruments Exchanges to trade commodity derivatives to enhance user convenience. The FSA conducts supervision of the “Comprehensive Exchange.” The amendment with regard to the “Comprehensive Exchange” became effective on March 11, 2014.

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

 

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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.

Base Erosion and Profit Shifting (BEPS)

In July 2013, the Organization for Economic Co-operation and Development (“OECD”) published the Action Plan on Base Erosion and Profit Shifting (“BEPS”) in order to prevent exploiting of gaps and mismatches in tax rules and artificial shifting of profits to low or no-tax locations. In October 2015, OECD published the final package of measures for a comprehensive, coherent and coordinated reform of the international tax rules for 15 key areas. These measures will apply once they are implemented either in domestic laws or in the network of bilateral tax treaties. Some of the deliverables published by OECD have been partially reflected to Japanese tax regulations by the tax reform adopted in 2015 and 2016.

Deregulation

The developments toward deregulation of the financial system including those described below have made the Japanese banking industry highly competitive.

Deregulation of Bank Engagement in the Securities Business

The gradual relaxation of the restrictions under the Securities and Exchange Act allowed banks to engage in the following business lines, after taking appropriate registration measures with the FSA:

 

   

underwriting and dealing in Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, commercial paper and certain bonds issued by special purpose companies;

 

   

selling beneficiary certificates of investment trusts and securities issued by an investment company; and

 

   

dealing in listed or OTC securities or derivatives transactions as well as in the securities intermediary business.

In addition, amendments to the FIEA and the Banking Act relating to firewalls and conflicts of interest between banks, securities companies and insurance companies became effective on June 1, 2009. 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 from being unfairly harmed through trading by the companies or by other companies within their group. For example, the companies may be required to create information barriers between departments and monitor how it executes transactions with customers.

Deregulation of Insurance Products

The gradual deregulation of the financial services industry permitted banks in Japan to offer an increased variety of insurance products, including pension-type insurance to the full range, as an agent.

Privatization of Japan Post Holdings Co., Ltd.’s subsidiaries

In December 2014, under the Postal Privatization Act, Japan Post Holdings Co., Ltd. (“Japan Post Holdings”), a joint stock corporation that holds shares of operating companies, published a plan for the listing of Japan Post Holdings, Japan Post Bank, one of the world’s largest deposit-taking institutions, and Japan Post

 

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Insurance Co., Ltd. (“Japan Post Insurance”) and the gradual disposition of its shares of Japan Post Bank and Japan Post Insurance down to approximately 50% ownership. In November 2015, each of Japan Post Holdings, Japan Post Bank and Japan Post Insurance publicly offered approximately 11% of their outstanding shares, respectively, and they were listed on the Tokyo Stock Exchange. Japan Post Bank is required to receive prior approval of the Government of Japan to expand its business until Japan Post Holdings disposes of at least half of the shares of Japan Post Bank.

Regulations in the 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.

The Bank’s New York branch is supervised by the Federal Reserve Bank of New York and the New York State Department of Financial Services, but its deposits are not insured (or eligible to be insured) by the Federal Deposit Insurance Corporation (“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 Business Oversight, 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 Banking and the Federal Reserve Bank of Dallas.

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 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 their U.S. “umbrella supervisor.”

Manufacturers Bank is a California state-chartered bank that is not a member of the Federal Reserve System. As a state non-member bank the deposits of which are insured by the FDIC, Manufacturers Bank is subject to regulation, supervision and examination by the FDIC and the California Department of Business Oversight.

In order to further expand our business in the U.S., we and the Bank obtained financial holding company status under the Bank Holding Company Act on May 7, 2013, which authorizes the expansion of the scope of services we provide in the U.S., including the underwriting and trading of securities and other investment banking services.

Restrictions on Business 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 the 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.

 

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As financial holding companies, we, the Bank and the companies under our control are permitted to engage in a broader range of activities in the U.S. and abroad than permitted for bank holding companies and their subsidiaries. Unless otherwise limited by the Federal Reserve Board, financial holding companies generally can engage, directly or indirectly in the U.S. and abroad, in financial activities, either de novo or by acquisition, by providing after-the-fact notice to the Federal Reserve Board. These financial activities include underwriting and dealing in securities, insurance underwriting and brokerage and making investments in non-financial companies for a limited period of time, as long as the financial holding company does not directly or indirectly manage the non-financial companies’ day-to-day activities, and the financial holding company’s banking subsidiaries engage only in permitted cross-marketing with the non-financial companies. If we or the Bank cease to qualify as financial holding companies, we could be barred from new financial activities or acquisitions, and have to discontinue the broader range of activities permitted to financial holding companies.

Other Prudential Restrictions

The Bank’s U.S. branches and Manufacturers Bank are subject to requirements and restrictions under U.S. 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. The U.S. 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 Bank.

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 of 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 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.

 

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Regulatory Requirements applicable to Financial Holding Companies

As financial holding companies, we and the Bank are subject to additional regulatory requirements. For example, we, the Bank and Manufacturers Bank, which is our U.S. insured depository institution subsidiary, must be “well capitalized,” meaning maintenance of a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10% under the revised capital standards of Basel III, which became effective on January 1, 2015 in the U.S. In addition, we, the Bank and Manufacturers Bank must be “well managed,” including maintenance of examination ratings that are at least satisfactory. Further, the Bank is also required to be well capitalized and well managed under its home country standards, which must be comparable to those required for a U.S. bank. Failure to comply with such requirements would require us and the Bank to prepare a remediation plan, and we would not be able to undertake new business activities or acquisitions based on our status as a financial holding company during any period of noncompliance without the prior approval of the Federal Reserve Board. Divestiture or termination of certain business activities in the U.S. may also be required as a consequence of failure to correct such conditions within 180 days.

Regulations for Stabilizing the Financial System

Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) 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 resolution of failing systemically significant financial institutions, OTC derivatives, the ability of banking entities to engage in proprietary trading activities and invest in hedge funds and private equity funds, consumer and investor protection, hedge fund registration, 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 (“OCC”), the Federal Reserve Board, the SEC, the FDIC, the Commodity Futures Trading Commission (“CFTC”), the Financial Stability Oversight Council and the Consumer Financial Protection Bureau.

In December 2013, the Federal Reserve Board, the SEC, the OCC, the FDIC, and the CFTC adopted final rules implementing what is known as the “Volcker Rule.” The final rules require banking entities to conform to certain restrictions on proprietary trading activities, hedge fund and private equity fund activities and certain other enumerated investment restrictions, but contain a number of exclusions and exemptions that substantially limit their extraterritorial reach. Concurrently, with the release of the final rules in December 2013, the Federal Reserve Board issued an order extending the conformance period until July 21, 2015. During the conformance period, banking entities must engage in good-faith efforts to conform their activities and investments to the requirements of the final rules by the conformance deadline. In December 2014, the Federal Reserve Board extended the conformance period to July 21, 2016 for certain investments in and relationships with hedge funds and private equity funds that were in place as of December 31, 2013, and announced its intention to further extend this conformance period until July 21, 2017. Although complying with the final rules could result in additional costs, or restrict or otherwise affect the way we conduct our business, the impact remains uncertain.

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 assets of $50 billion or more. In imposing heightened prudential standards on non-U.S. financial institutions 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 non-U.S. bank holding company is subject to comparable home country standards.

On February 18, 2014, the Federal Reserve Board adopted final rules that will apply enhanced prudential standards to the U.S. operations of large non-U.S. banking organizations, including us. The final rules, effective

 

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July 1, 2016, will require each of certain large non-U.S. banking organizations, such as us, to certify that it is subject to home country capital standards that are broadly consistent with the Basel capital framework, including Basel III; conduct home country capital stress tests that are comparable to U.S. standards; comply with a qualitative liquidity framework, including, among other things, a U.S. liquidity buffer requirement for its U.S. branches and agencies based on the results of internal liquidity stress testing; and establish a U.S. risk committee that understands the risk management policies and framework of its U.S. operations and has a general understanding of the risk management practices of the U.S. operations.

Under the final rules, non-U.S. banking organizations with combined U.S. assets (excluding assets held by its U.S. branches and agencies) of $50 billion or more, will be required to establish a separately capitalized top-tier U.S. intermediate holding company. However, this requirement will not apply to us. Although proposed rules have been released, the final rules for single counterparty credit limits and for early remediation have yet to be promulgated.

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 States. In addition, the Dodd-Frank Act requires that the lending limits take into account credit exposure arising from derivative transactions and securities lending, securities borrowing, and repurchase agreements and reverse repurchase agreements with counterparties. In June 2013, the OCC adopted the final rules that implement these new lending limits, and compliance with these new lending limits is required for our New York, Los Angeles and San Francisco branches from October 1, 2013, in addition to existing state lending limits that apply to the branches. Additionally, as a California state-chartered bank, Manufacturers Bank is subject to state lending limits, which also apply to credit exposure arising from derivative transactions.

Furthermore, 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. In October 2012, the final joint rules of the CFTC and the SEC that further define “swap” and “security based swap” became effective. As a result, certain entities are required to register with the CFTC as “swap dealers” or “major swap participants” and our subsidiary, SMBC Capital Markets, Inc., became provisionally registered as a swap dealer on or around December 31, 2012. While some of the U.S. swaps requirements are already final and effective, others are subject to further rulemaking or deferred compliance dates. Mandatory clearing, trade execution and reporting requirements for swaps took effect in the first half of 2013.

Furthermore, the Dodd-Frank Act requires the SEC to establish rules requiring issuers with listed securities, which may include non-U.S. 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.

Laws Prohibiting Money Laundering and Terrorist Financing

The Bank Secrecy Act / USA PATRIOT Act of 2001

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. Certain provisions of the PATRIOT Act expired in June 2015 and were extended in part by the USA FREEDOM Act of 2015, enacted on June 2015.

 

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U.S. Sanctions Targeting Iran Related Activities

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, as amended, authorized the imposition of sanctions against non-U.S. financial institutions, such as us, if they are determined by the U.S. Secretary of the Treasury to have facilitated “significant transactions” or provided “significant financial services” for certain Iran-linked individuals or entities or the Islamic Revolutionary Guard Corps. Non-U.S. financial institutions that engage in sanctionable activity could lose their ability to open or maintain correspondent or payable-through accounts with U.S. financial institutions, among other possible sanctions.

In December 2011, the U.S. government adopted Section 1245 of the National Defense Authorization Act for Fiscal Year 2012 (“2012 NDAA”), which broadened the range of sanctionable transactions to include conducting or facilitating “significant financial transactions” with the Central Bank of Iran or other Iranian financial institutions designated for sanctions under the International Emergency Economic Powers Act in connection with Iran’s weapons of mass destruction proliferation or support for international terrorism. Following Implementation Day, this sanction no longer applies to significant financial transactions with the Central Bank of Iran.

In addition, in July 2012, Executive Order 13622 was issued, which, as amended, authorized the U.S. Secretary of the Treasury, in consultation with the U.S. Secretary of State, to impose correspondent account sanctions on any foreign financial institution that knowingly conducted or facilitated a significant financial transaction with the National Iranian Oil Company or Naftiran Intertrade Company, or that knowingly conducted or facilitated a significant transaction for the purchase, acquisition, sale, transport or marketing of petroleum, petroleum products or petrochemical products from Iran, with certain exceptions. On Implementation Day, Executive Order 13622 was revoked by Executive Order 13716.

Further, in August 2012, the President signed the Iran Threat Reduction and Syria Human Rights Act of 2012 into law, which strengthened sanctions on Iran, especially those aimed at third-country nationals who engaged in certain business with Iran, and included measures relating to human rights abuses in Iran and Syria. It authorized the imposition of secondary sanctions penalties on non-U.S. persons found to have engaged in specified activities relating to Iran.

In addition, the Iran Freedom and Counter-Proliferation Act of 2012 (“IFCA”), which is included in the U.S. National Defense Authorization Act for Fiscal Year 2013, imposed, among other things, new sanctions against the energy, shipping and shipbuilding sectors of Iran, as well as Iranian port operators, and the sale, supply or transfer to or from Iran of certain precious and other metals and materials. Executive Order 13645 targeted, among other things, the automotive sector of Iran and transactions in Iran’s currency, the rial. The IFCA and Executive Order 13645 provided for the imposition of sanctions on persons, including foreign financial institutions, that knowingly engaged in activities related to the sectors and conduct targeted by the IFCA and Executive Order 13645, and activities that involved certain Iranian persons included on the Specially Designated Nationals and Blocked Persons List (the “SDN List”) maintained by OFAC. On Implementation Day, Executive Order 13645 was revoked by Executive Order 13716. Also on Implementation Day, the United States waived the imposition of certain correspondent or payable-through account sanctions under the IFCA, and committed to refrain from imposing certain discretionary blocking sanctions under the IFCA. It continues to be sanctionable under the IFCA to knowingly conduct or facilitate significant financial transactions on behalf of any Iranian person on the SDN List.

The U.S. Secretary of State announced on March 20, 2012 that Japan was among a number of countries that had significantly reduced the volume of crude oil purchases from Iran, and that therefore the 2012 NDAA sanctions would not apply to Japanese financial institutions for a period of 180 days, which period could be renewed based on ongoing reductions in crude oil purchases from Iran (“NDAA Exception”). The NDAA

 

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Exception was renewed on September 14, 2012, March 13, 2013, and September 6, 2013. The NDAA Exception, which was subject to certain restrictions, also exempted Japanese financial institutions from sanctions under certain provisions of Executive Order 13622, the IFCA, and Executive Order 13645.

On January 20, 2014, the U.S. government issued certain temporary sanctions waivers as part of the November 24, 2013 Joint Plan of Action (“JPOA”) among the P5 + 1 and Iran (“JPOA Waivers”). While in effect, the JPOA Waivers superseded the NDAA Exception, which expired on March 5, 2014. The effective period of the JPOA Waivers (“JPOA Relief Period”) was originally from January 20, 2014 through July 20, 2014, but was successively extended through July 13, 2015. Pursuant to the JPOA Waivers, the U.S. government agreed not to seek reductions in the volume of Iranian crude oil purchased by current authorized purchasers, including Japan, during the JPOA Relief Period. Additionally, pursuant to the JPOA Waivers, non-U.S. financial institutions, such as us, that engaged in certain transactions initiated and completed during the JPOA Relief Period relating to exports of Iranian petrochemical products, petroleum and petroleum products, Iran’s automotive sector, Iran’s trade in gold and precious metals, and the supply and installation of certain spare parts and services for civil aircraft in Iran would not be targeted for secondary sanctions under U.S. law. On July 14, 2015, the sanctions relief provided for in the JPOA was further extended.

As part of the JPOA, the P5 + 1 and Iran agreed on a process to authorize or facilitate the release in installments over the initial JPOA Relief Period (January 20, 2014 through July 20, 2014) of $4.2 billion of Iran’s restricted funds held in banks outside Iran and outside the United States, contingent on Iran fulfilling its commitments under the JPOA. The United States Government worked with non-U.S. financial institutions to implement the release of such funds to Iran. As part of the extension of the JPOA Relief Period to November 24, 2014, the P5 + 1 agreed to allow Iran access to an additional $2.8 billion of its restricted assets in installments. According to the U.S. Treasury Department, the P5+1 fulfilled their commitments to facilitate the release of $4.2 billion during the initial JPOA Relief Period and to facilitate the release of a further $2.8 billion through November 24, 2014. Further, as part of a further extension of the JPOA Relief Period, the P5 + 1 agreed to facilitate the release in installments of an additional $4.9 billion of Iran’s restricted funds during the period beginning on November 25, 2014, and ending on June 30, 2015. In addition, the JPOA, among other things, established a financial channel to facilitate humanitarian trade for Iran’s domestic needs using Iranian oil revenues held abroad. For a description of the remittances the Bank conducted in connection with the export of humanitarian goods to Iran under applicable laws and regulations, see “—Disclosure Pursuant to Section 13(r) of the Securities Exchange Act of 1934.”

In April 2015, the parties to the JPOA reached an understanding on the framework for the JCPOA. In May 2015, President Obama signed into law the Iran Nuclear Agreement Review Act of 2015, which established a mechanism for Congressional review of any new agreement reached between the United States and Iran related to Iran’s nuclear program.

On July 14, 2015, the P5 + 1 and Iran, with the European Union, agreed on the final text of the JCPOA. The JCPOA established a framework for providing Iran with phased sanctions relief upon verification that Iran had implemented key nuclear commitments. Under the JCPOA, U.S. sanctions relief is provided through the suspension and eventual termination of nuclear-related secondary sanctions, which began on Implementation Day, January 16, 2016, when the International Atomic Energy Agency verified that Iran had implemented key nuclear-related measures described in the JCPOA. As noted above, certain U.S. sanctions authorities targeting Iran and targeting certain Iran-related transactions and activities were revoked or waived on January 16, 2016.

Even after Implementation Day, certain secondary sanctions remain in effect, including those targeting significant transactions involving SDNs or the Islamic Revolutionary Guard Corps. Non-U.S. financial institutions that engage in transactions targeted by secondary sanctions could lose their ability to open or maintain correspondent or payable-through accounts with U.S. financial institutions, among other possible restrictive measures. It is the Bank’s policy not to conduct activities targeted by remaining secondary sanctions.

 

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Pursuant to the JCPOA, there also remains a possibility that, if Iran is found to be in non-compliance with its commitments under the JCPOA, sanctions that have been waived or lifted, including nuclear-related secondary sanctions, could be re-imposed.

Ukraine Freedom Support Act of 2014

In order to deter the Russian government from further destabilizing and invading Ukraine, the U.S. government enacted H.R. 5859, the Ukraine Freedom Support Act of 2014 (signed into law on December 18, 2014). Among other things, the Act authorizes prohibitions or strict limitations on the opening or maintaining of correspondent or payable-through accounts in the United States by non-U.S. financial institutions determined by the U.S. government (i) to have knowingly engaged in on or after December 18, 2014 in significant transactions involving certain activities described in the Act, including those involving individuals or entities on whom sanctions are imposed pursuant to the Act for making a significant investment in a project for the extraction of deepwater, Arctic offshore or shale formation crude oil in Russia, or (ii) to have knowingly facilitated, on or after June 16, 2015, a significant financial transaction on behalf of any Russian individual or entity included on the SDN List pursuant to Ukraine-related sanction programs.

Foreign Account Tax Compliance Act

Provisions of the U.S. tax law commonly referred to as the Foreign Account Tax Compliance Act (“FATCA”), which became effective on July 1, 2014, aim to prevent U.S. persons from hiding their financial assets or evading their U.S. federal income tax obligations by the use of offshore accounts. A foreign financial institution that has entered into an agreement with the U.S. Internal Revenue Service (“IRS”) pursuant to which it agrees to comply with FATCA, referred to as a “participating foreign financial institution” (“PFFI”), is required to perform specified due diligence, reporting and withholding functions (a “PFFI agreement”). Specifically, under FATCA, a PFFI is required to ascertain the U.S. status of customers through specified due diligence and report certain information annually to the IRS. In cases where customers are not compliant with FATCA, PFFIs are obligated to carry out specified reporting and withholding procedures as prescribed. The consequences for foreign financial institutions that are not compliant with FATCA include being subjected to a 30% withholding tax on certain withholdable payments from U.S. sources and reporting to the IRS.

The United States entered into intergovernmental agreements or reached agreements in substance with more than 100 countries in furtherance of the objectives of FATCA, which modify the operation of FATCA with respect to financial institutions located in those countries. On June 11, 2013 the United States and Japan entered into an intergovernmental agreement to facilitate the implementation of FATCA pursuant to which Japanese financial institutions (such as us and certain of our Group companies) are directed by the Japanese authorities to register with the IRS and fulfill obligations consistent with those required under a PFFI agreement. We have registered with the IRS to become a PFFI. We are committed to complying with FATCA as a PFFI and abiding by the terms of our PFFI agreement with the IRS within the jurisdictions in which we operate and in accordance with the time frame set out by the IRS. We intend to closely monitor FATCA developments and evolving industry practices to ensure continued compliance with FATCA moving forward.

Other Regulations in the United States

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:

 

   

sales methods;

 

   

trade practices among broker-dealers;

 

   

use and safekeeping of customers’ funds and securities;

 

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capital structure;

 

   

record-keeping;

 

   

the financing of customers’ purchases; and

 

   

the conduct of directors, officers and employees.

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.

Regulations in Other Jurisdictions

Elsewhere in the world, our operations are subject to regulation and control by local central banks and monetary authorities.

Disclosure Pursuant to Section 13(r) of the Securities Exchange Act of 1934

Section 13(r) of the Securities Exchange Act of 1934, as amended, requires an issuer to disclose whether it or any of its affiliates knowingly engaged in certain activities or transactions relating to Iran or with individuals or entities designated by the U.S. government under specified Executive Orders, even if those activities are not prohibited by U.S. law and are conducted outside the United States by non-U.S. affiliates. During the twelve months ended March 31, 2016, one affiliate of SMFG, SMBC, engaged in activities subject to disclosure under Section 13(r). SMBC conducted these activities consistent with its internal policies and procedures, the policies and procedures of SMFG, and applicable laws and regulations, and to the extent they are not sanctionable under U.S. secondary sanctions.

SMBC issued letters of credit and provided remittance and other settlement services in connection with customers’ trade transactions between Japan and Iran. These transactions principally involved the importation of oil into Japan or exportation of civilian commercial products from Japan and were conducted with Iranian banks, including the Central Bank of Iran and one other bank owned by the Government of Iran. Under certain exceptions and U.S. sanctions relief measures granted to Japanese financial institutions, SMBC supported a Japanese importing company by paying bills of exchange in connection with imports of crude oil from an Iranian oil company owned by the Government of Iran that was, at the time of certain of the transactions, designated under Executive Order 13382 but that was removed from the SDN List on January 16, 2016. These transactions did not involve the settlement of U.S. dollar-denominated payments cleared through U.S. banks. SMBC has informed SMFG that it intends to continue to engage in these types of transactions to the extent permitted under applicable regulations and to the extent they are not sanctionable under U.S. secondary sanctions. For the twelve months ended March 31, 2016, the gross revenue related to these transactions was ¥8.7 million, representing about 0.0003% of SMFG’s total interest and fee income. SMFG does not allocate direct costs to interest and fee income and therefore does not calculate net profits with respect to these transactions.

In addition, in accordance with applicable laws, regulations and sanctions relief measures (including sanctions relief under the JPOA, while it was in effect), SMBC has conducted certain settlement services related to humanitarian trade with Iran. We are voluntarily disclosing such transactions, although we do not believe those transactions are subject to disclosure under Section 13(r) of the Securities Exchange Act of 1934. The JPOA/JCPOA provide for the establishment of a financial channel to facilitate humanitarian trade for Iran’s domestic needs using Iranian oil revenues held abroad. The overall framework to provide these services is based on an agreement between the U.S. and Japanese authorities and was reviewed by U.S. and Japanese authorities for compliance with applicable laws and regulations. The services provided under the framework are permitted

 

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under certain conditions; the remittances are required to be processed in Japanese yen through a “Special Purpose Account” for humanitarian trade; and the sellers of the humanitarian goods, namely food, agricultural products, medicines and medical devices, are limited to Japanese entities and entities permitted by U.S. regulators. To facilitate the export of humanitarian goods to Iran, at the request of U.S. and Japanese regulators and with the written authorization of the U.S. government, SMBC has provided remittances in connection with the export of humanitarian goods to Iran starting in March 2014. These transactions were conducted through the use of yen accounts maintained with SMBC in Japan by a Government of Iran owned Iranian financial institution. These transactions did not involve U.S. dollars or clearing services of U.S. banks for the settlement of payments. SMBC intends to continue to provide these remittance and other settlement services in connection with the export of humanitarian goods to Iran to the extent that U.S. and Japanese regulators continue to make such requests, and that the services are permitted under applicable laws and regulations.

In the past, SMBC has issued performance bonds that supported various projects, including the construction of petroleum plants in Iran. Some of these performance bonds had counterparties that were entities controlled by the Government of Iran. All of these performance bonds have matured, and SMBC has not renewed and will not renew them, but SMBC continues to have obligations under the matured performance bonds until they are returned or cancelled by the beneficiaries. SMBC has also received fees from its customers on whose behalf it issued the performance bonds. For the twelve months ended March 31, 2016, the gross revenue relating to these transactions was ¥29.7 million, representing less than 0.0011% of SMFG’s total interest and fee income. As noted above, SMFG does not allocate direct costs to interest and fee income and therefore does not calculate net profits with respect to these transactions. SMBC has informed SMFG that it intends to continue to accept fee income from its customers for whose account the performance bonds were issued and to pay the relevant fees to the Iranian banks, to the extent authorized by the Ministry of Finance of Japan or otherwise permitted under applicable regulations, until the bonds are returned or cancelled. However, SMBC strongly urges the relevant customers to ask the beneficiaries to agree to return or cancel these performance bonds.

SMBC has frozen an account of an Iranian bank designated under Executive Order 13224 pursuant to Japanese foreign exchange laws, and has frozen the U.S. dollar accounts of all Iranian banks. SMBC still maintains two Japanese yen accounts of government-owned Iranian banks, including an account for the Central Bank of Iran, and certain transactions described in this disclosure were conducted through the use of such accounts. These transactions were conducted in accordance with Japanese law, and we do not believe that the transactions were sanctionable under U.S. sanctions, due to the exception for Japanese financial institutions under the 2012 NDAA and waivers pursuant to the JCPOA or JPOA that were in effect at the time the transactions occurred. For a description of the exception under the 2012 NDAA and JCPOA/JPOA Waivers described in this paragraph, see “—Regulations in the United States—Laws Prohibiting Money Laundering and Terrorist Financing.” The gross revenue attributable to the accounts of government-owned Iranian banks for the twelve months ended March 31, 2016, was less than ¥0.1 million, representing less than 0.0001% of SMFG’s total interest and fee income. SMFG does not allocate direct costs to interest and fee income and therefore does not calculate net profits with respect to these transactions. SMBC has informed SMFG that it intends to continue to maintain the Iranian accounts described above to the extent permitted under applicable laws and regulations.

As of the date of this annual report, to our knowledge, there is no other activity for the twelve months ended March 31, 2016 that requires disclosure under Section 13(r) of the Securities Exchange Act of 1934.

 

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4.C.    ORGANIZATIONAL STRUCTURE

The following chart presents our corporate structure summary at March 31, 2016.

 

LOGO

 

(1) These companies are our associates.
(2) Cedyna Financial Corporation merged with SAKURA CARD CO., LTD. on April 1, 2016.

As the ultimate holding company of the Group, we are responsible for:

 

   

group strategy and management;

 

   

group resource allocation;

 

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group financial accounting;

 

   

investor relations;

 

   

capital strategy;

 

   

group IT strategy;

 

   

HR management for group executives;

 

   

group risk management, internal control and compliance;

 

   

compensation schemes; and

 

   

efficiently harmonizing our operations on a Group-wide basis.

Principal Subsidiaries

Our principal subsidiaries at March 31, 2016 are shown in the list below. We consolidate all entities that we control. We control an entity when we are exposed, or have rights, to variable returns from our involvement with the entity and have the ability to affect those returns through our power over the entity.

Principal domestic subsidiaries

 

Company Name

  Proportion
of Ownership
Interest(1)
    Proportion
of Voting
Rights(1)
   

Main Business

    (%)     (%)      

Sumitomo Mitsui Banking Corporation

    100.0        100.0      Commercial banking

SMBC Trust Bank Ltd.  

    100.0        100.0      Trust Banking

THE MINATO BANK, LTD.

    6.0        46.4 (2)(3)    Commercial banking

Kansai Urban Banking Corporation

    59.8        60.1      Commercial banking

SMBC Guarantee Co., Ltd.

    100.0        100.0      Credit guarantee

Sumitomo Mitsui Finance and Leasing Company, Limited

    60.0        60.0      Leasing

SMBC Nikko Securities Inc.

    100.0        100.0      Securities

SMBC Friend Securities Co., Ltd.

    100.0        100.0      Securities

Sumitomo Mitsui Card Company, Limited

    65.9        65.9      Credit card

Cedyna Financial Corporation(4)

    100.0        100.0      Credit card and consumer credit

SMBC Consumer Finance Co., Ltd.  

    100.0        100.0      Consumer lending

SAKURA CARD CO., LTD.(4)

    100.0        100.0      Credit card

Mobit Co., LTD.

    100.0        100.0      Consumer lending

SMM Auto Finance, Inc.

    51.0        51.0      Automobile sales financing

SMBC Finance Service Co., Ltd.

    100.0        100.0      Collecting agent and factoring

The Japan Research Institute, Limited

    100.0        100.0      System development, data processing, management consulting and economic research

SAKURA KCS Corporation

    50.2        50.2      System engineering and data processing

Financial Link Co., Ltd.

    100.0        100.0      Data processing service and consulting

SMBC Venture Capital Co., Ltd.

    40.0        40.0 (3)    Venture capital

SMBC Consulting Co., Ltd.

    100.0        100.0      Management consulting and information services

Japan Pension Navigator Co., Ltd.

    69.7        69.7      Operational management of defined contribution pension plans

 

(1) Percentages of proportion of ownership interest and proportion of voting rights have been truncated.
(2) We have a 6.0% direct holding in THE MINATO BANK, LTD., and can control a further 40.4% of the voting rights held by the Bank’s retirement benefit trust under contractual agreements between the Bank and the retirement benefit trust.
(3) These companies are accounted for as subsidiaries, despite our holdings of less than 50% of the voting rights, because we are able to govern the financial and operating policies of these companies under a statute or an agreement, or by delegating the majority of the members of the board of directors.
(4) Cedyna Financial Corporation merged with SAKURA CARD CO., LTD. on April 1, 2016.

 

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Principal foreign subsidiaries

 

Company Name

   Country of
Incorporation
   Proportion
of Ownership
Interest(1)
     Proportion
of Voting
Rights(1)
     Main Business
          (%)      (%)       

Sumitomo Mitsui Banking Corporation Europe Limited

   U.K.      100.0         100.0       Commercial banking

Sumitomo Mitsui Banking Corporation (China) Limited

   China      100.0         100.0       Commercial banking

Manufacturers Bank

   U.S.A.      100.0         100.0       Commercial banking

Sumitomo Mitsui Banking Corporation of Canada

   Canada      100.0         100.0       Commercial banking

Banco Sumitomo Mitsui Brasileiro S.A.

   Brazil      100.0         100.0       Commercial banking

JSC Sumitomo Mitsui Rus Bank

   Russia      100.0         100.0       Commercial banking

PT Bank Sumitomo Mitsui Indonesia

   Indonesia      98.4         98.4       Commercial banking

Sumitomo Mitsui Banking Corporation Malaysia Berhad

   Malaysia      100.0         100.0       Commercial banking

SMBC Leasing and Finance, Inc.

   U.S.A.      100.0         100.0       Leasing

SMBC Aviation Capital Limited

   Ireland      90.0         90.0       Leasing

SMBC Nikko Securities America, Inc. 

   U.S.A.      100.0         100.0       Securities

SMBC Nikko Capital Markets Limited

   U.K.      100.0         100.0       Securities

SMBC Capital Markets, Inc.

   U.S.A.      100.0         100.0       Derivatives

 

(1) Percentages of proportion of ownership interest and proportion of voting rights have been truncated.

4.D.    PROPERTY, PLANT AND EQUIPMENT

The assets for rent we own for the purpose of operating leases mainly consist of aircraft for the leasing business. 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 Bank’s East Tower in Marunouchi, with a net carrying value of ¥175 billion, including the land and building, at March 31, 2016.

The following table shows the net carrying amount of our tangible fixed assets at March 31, 2016.

 

     At March 31, 2016  
     (In millions)  

Assets for rent

   ¥ 1,545,360   

Land

     512,819   

Buildings

     375,679   

Leased assets

     7,558   

Others

     149,535   
  

 

 

 

Total

   ¥ 2,590,951   
  

 

 

 

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, 2016 was approximately 722,000 square meters for owned land and approximately 15,000 square meters for leased land.

We are not aware of any material environmental issues that may affect the utilization of our assets.

 

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Item 4A. Unresolved Staff Comments

None.

 

Item 5. Operating and Financial Review and Prospects

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

Our results of operations and financial condition are significantly affected by developments in Japan as well as the global economy.

For the fiscal year ended March 31, 2016, Japanese gross domestic product (“GDP”) increased by 0.8%, compared with a decrease of 0.9% in the previous fiscal year, based on data published in June 2016 by the Cabinet Office of the Government of Japan.

For the period from April to June 2015, the quarter-on-quarter growth rate of Japanese GDP was minus 0.4%, primarily due to a decline in exports of goods and services affected by the slowdown of emerging economies. However, Japanese GDP increased by 0.4% on a quarter-on-quarter basis for the period from July to September 2015, reflecting improvements in the private consumption, private investment and exports of goods and services. For the period from October to December 2015, Japanese GDP decreased by 0.4% on a quarter-on-quarter basis with private consumption decreasing. Thereafter, for the period from January to March 2016, Japanese GDP increased by 0.5% on a quarter-on-quarter basis.

Private consumption, which accounts for about 58% of Japanese GDP, decreased by 0.2% for the fiscal year ended March 31, 2016. It decreased by 0.8% on a quarter-on-quarter basis for the period from April to June 2015. However, it then showed some resilience, reflecting the gradual improvement in the employment and income situation. For the period from July to September 2015, private consumption increased by 0.5% on a quarter-on-quarter basis. For the period from October to December 2015, it decreased by 0.8% on a quarter-on-quarter basis. Thereafter, for the period from January to March 2016, it increased by 0.6% on a quarter-on-quarter basis.

Private investment, which accounts for about 16% of Japanese GDP, consists of capital investments by business and private residential investments. Capital investments by business increased by 2.0% for the fiscal year ended March 31, 2016. For the period from April to June 2015, they decreased by 1.2% on a quarter-on-quarter basis. Thereafter, they increased, on a quarter-on-quarter basis, by 0.8% for the period from July to September 2015 and by 1.3% for the period from October to December 2015, reflecting the improvement in corporate earnings. Then, for the period from January to March 2016, they decreased by 0.7% on a quarter-on-quarter basis. Private residential investments increased by 2.4% for the fiscal year ended March 31, 2016. For the periods from April to June 2015 and July to September 2015, they increased, on a quarter-on-quarter basis, by 2.2% and 1.7% respectively, reflecting the steady improvement in the employment and income situation. However, for the period from October to December 2015, private residential investments decreased by 1.0% on a quarter-on-quarter basis. Then, for the period from January to March 2016, they decreased by 0.7% on a quarter-on-quarter basis.

Changes in private inventories contributed 0.3 percentage points to Japanese GDP growth for the fiscal year ended March 31, 2016. For the period from April to June 2015, they contributed 0.3 percentage points to Japanese GDP growth on a quarter-on-quarter basis, but negatively impacted Japanese GDP growth by 0.1 percentage points on a quarter-on-quarter basis for the period from July to September 2015. Thereafter, changes

 

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in private inventories pulled down Japanese GDP growth, on a quarter-on-quarter basis, by 0.2 percentage points for the period from October to December 2015 and by 0.1 percentage points for the period from January to March 2016, respectively.

The ratio of exports of goods and services to Japanese GDP was about 17%, and exports of goods and services increased by 0.4% for the fiscal year ended March 31, 2016. For the period from April to June 2015, exports of goods and services decreased by 4.8% on a quarter-on-quarter basis, due to the slowdown of emerging economies, notably China. Although exports of goods and services increased by 2.6% on a quarter-on-quarter basis for the period from July to September 2015, they decreased by 0.8% on a quarter-on-quarter basis for the period from October to December 2015. Thereafter, for the period from January to March 2016, they increased by 0.6% on a quarter-on-quarter basis.

The ratio of imports of goods and services to Japanese GDP was about 15%, and imports of goods and services decreased by 0.1% for the fiscal year ended March 31, 2016. For the period from April to June 2015, imports of goods and services decreased by 2.5% on a quarter-on-quarter basis. Thereafter, they increased by 1.7% on a quarter-on-quarter basis for the period from July to September 2015, reflecting the robust domestic demand, although they decreased by 1.1% on a quarter-on-quarter basis for the period from October to December 2015. Thereafter, for the period from January to March 2016, they decreased by 0.4% on a quarter-on-quarter basis.

Industrial production, as a whole, was flat throughout the fiscal year ended March 31, 2016.

The employment situation improved during the fiscal year ended March 31, 2016. The active job openings-to-applicants ratio continued to improve as a whole. In addition, the unemployment rate remained relatively low, and it was 3.2% in March 2016, a decrease of 0.2% from the same month of the previous year, based on the Labor Force Survey by the Statistics Bureau in the Ministry of Internal Affairs and Communications. For the periods from April to June 2015 and July to September 2015, compensation of employees increased, on a quarter-on-quarter basis, by 0.1% and 0.8%, respectively. Thereafter, for the periods from October to December 2015 and January to March 2016, it increased, on a quarter-on-quarter basis, by 0.5% and 1.3%, respectively.

Further, according to Teikoku Databank, a research institution in Japan, there were approximately 8,400 corporate bankruptcies in Japan during the fiscal year ended March 31, 2016, a decrease of 7.0% from the previous fiscal year, involving approximately ¥1.9 trillion in total liabilities, an increase of 1.0% from the previous fiscal year.

In Japanese financial and capital markets, the uncollateralized overnight call rate, which is the benchmark short-term interest rate, remained at relatively low levels during the fiscal year ended March 31, 2016, due to the ongoing provision of ample funds by the BOJ. In particular, following the introduction of a negative interest rate policy by the BOJ in February 2016 as part of the BOJ’s quantitative and qualitative monetary easing, it further declined. The yield on newly issued Japanese government bonds with a maturity of 10 years, which is the benchmark long-term interest rate, remained at relatively low levels, declining to minus 0.029% at March 31, 2016, due to the introduction of the negative interest rate policy mentioned above.

The Nikkei Stock Average, which is a price-weighted average of 225 stocks listed on the Tokyo Stock Exchange First Section, rose from ¥19,206.99 at March 31, 2015 to ¥20,868.03 at June 24, 2015, its highest closing level since December 1996, reflecting the improvement in corporate earnings. However, it then dropped to ¥16,758.67 at March 31, 2016, reflecting the sudden fall in the Chinese stock market and other factors.

The yen appreciated against the U.S. dollar from ¥120.21 at March 31, 2015 to ¥112.43 at March 31, 2016, according to the statistical data published by the BOJ.

 

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As for the global economy for the fiscal year ended March 31, 2016, economies of developed countries such as the U.S. and certain European countries continued to recover gradually, despite a slowdown in the pace of growth of emerging economies.

The U.S. economy continued to recover for the fiscal year ended March 31, 2016, supported by robust household spending, although the corporate sector was relatively weak. The European economy continued to steadily recover for the fiscal year ended March 31, 2016. On the other hand, the growth momentum in China and other Asian economies continued to be slow for the fiscal year ended March 31, 2016. For further information on exposures to certain European countries, see “Item 5.A. Operating Results—Financial Condition—Exposures to Selected European Countries.”

In addition to economic factors and conditions, we expect that our results of operations and financial condition 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 BCBS and other international bodies are leading efforts to formulate enhanced regulations, including in the areas of capital adequacy and liquidity. The BCBS published the Basel III rules text in December 2010, reflecting agreement on global regulatory standards on capital adequacy and liquidity of internationally active banks. The new rules started to be phased in on January 1, 2013 and will be fully applied from January 2019. To reflect the principal risk-weighted capital measures of the Basel III rules text, the FSA has promulgated new capital adequacy requirements which started to be phased in on March 31, 2013 and will be fully applied from March 31, 2019. For a more detailed description of the capital adequacy rules based on Basel III, see “Item 4.B. Business Overview—Regulations in Japan.”

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 resolution 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, consumer and investor protection, hedge fund registration, and securitization. For a more detailed description of the Dodd-Frank Act, see “Item 4.B. Business Overview—Regulations in the United States.”

For a more detailed description of regulations to which we are subject, 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—Regulations in Japan, Regulations in the United States, Regulations in Other Jurisdictions and Description of Operations and Principal Activities—Management Policies.”

Factors Affecting Results of Operation

Income (Loss)

We have three principal sources of operating income: net interest income, net fee and commission income, and net income from trading/investment securities.

Net Interest Income. Net interest income, or the difference between interest income and interest expense, is determined by:

 

   

the amount of interest-earning assets and interest-bearing liabilities;

 

   

the interest spread;

 

   

the general level of interest rates; and

 

   

the proportion of interest-earning assets to interest-bearing liabilities.

 

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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 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% in October 2008 and by an additional 0.2 percentage points to 0.1% in December 2008 in order to address market conditions. Following these policy interest rate changes, we lowered our short-term prime rate by 0.2 percentage points from 1.675% to 1.475% in January 2009 and our ordinary deposit rate by 0.02 percentage points from 0.04% to 0.02% in September 2010. In October 2010, the BOJ lowered its target for the uncollateralized overnight call rate to a range of 0% to 0.1% to pursue a virtual zero interest rate policy. In February 2012, the BOJ clarified its monetary policy stance to enhance monetary easing, with the aim of achieving the goal of 1% year-on-year rate of increase in the consumer price index (“CPI”). Moreover, in January 2013, the BOJ decided to set the price stability target at 2% in terms of the year-on-year rate of increase in the CPI and pursue aggressive monetary easing. In order to achieve the price stability target at the earliest possible time, the BOJ announced in April 2013 the introduction of “quantitative and qualitative monetary easing” including doubling the monetary base and the amounts outstanding of Japanese government bonds as well as exchange-traded funds in two years. In addition, the BOJ announced on October 31, 2014 the expansion of its “quantitative and qualitative monetary easing” and on December 18, 2015 the introduction of “supplementary measures for quantitative and qualitative monetary easing.” On January 29, 2016, the BOJ announced the introduction of “quantitative and qualitative monetary easing with a negative interest rate” (“negative interest rate policy”), and began to implement a negative interest rate policy on February 16, 2016. Under the negative interest rate policy, the BOJ has adopted a multi-tier system where the outstanding balance of each financial institution’s current account at the BOJ is divided into three tiers, to each of which a positive interest rate, a zero interest rate and a negative interest rate of minus 0.1 percent are applied, respectively. After these policy interest rate changes, the Bank lowered its ordinary deposit rate by 0.019 percentage points from 0.02% to 0.001% in February 2016.

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:

 

     At March 31,  
     2016     2015     2014  

Short-term prime rate

     1.475     1.475     1.475

Three-month TIBOR

     0.099        0.172        0.212   

Ordinary deposit rate

     0.001        0.020        0.020   

Long-term prime rate

     0.950        1.150        1.200   

Ten-year swap rate

     0.149        0.576        0.825   

It 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

 

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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 life insurance products, and investment banking businesses.

Net Income from Trading/Investment Securities. 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, foreign 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 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. dollars. 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.

Operating income from other than these three principal sources is included in “Net income from financial assets at fair value through profit or loss” or “Other income.” 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 the instruments such as hybrid instruments classified as financial assets at fair value through profit or loss. It also includes interest and dividend income on these instruments. Other income consists primarily of income from operating leases conducted by SMFL and income related to IT solution services.

 

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Expenses

Impairment Charges on Financial Assets. Our impairment charges are recorded primarily due to impairment on loans and advances and on investment securities.

Impairment charges on loans and advances are affected by the economic environment and financial conditions of borrowers. 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, publicity and advertising expenses, and communication expenses).

Other Expenses. Other expenses consist primarily of cost of operating leases, costs related to IT solution services and IT systems, 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 the investments in 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 Stock Average increased by 29.5% from ¥14,827.83 at March 31, 2014, to ¥19,206.99 at March 31, 2015, and decreased by 12.7% to ¥16,758.67 at March 31, 2016. At March 31, 2016, we had net unrealized gains on domestic equity securities of ¥2,348,888 million, a decrease of ¥682,838 million from ¥3,031,726 million at March 31, 2015. For more information, see “Item 5.A. Operating Results—Financial Condition—Investment Securities.”

Strengthening of Equity Capital

In response to the imposition of more stringent regulatory capital requirements, we have been taking a proactive approach to managing our risk-weighted capital ratio by focusing on increasing qualifying capital, including by building up our retained earnings, identifying risks, and controlling risk-weighted assets.

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, 2016 was ¥120.16 per $1.00, compared to the

 

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previous fiscal year’s average exchange rate of ¥109.76 per $1.00. The percentage of revenue we earned from our foreign operations for the fiscal years ended March 31, 2016 and 2015 was 23% and 24%, respectively. For more information, see “Item 4.B. Business Overview—Revenues by Region.”

Critical Accounting Estimates and Judgments

Our financial position and results of operations 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 the 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 impaired loans that are not individually significant and non-impaired 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. To estimate the allowance for loan losses for non-impaired loans, which reflects incurred but not yet identified losses for the period between the impairment occurring and the loss being identified, management develops assumptions and methodologies to estimate the loss identification period.

Management 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. Impairment charges on loans and advances amounting to ¥118,750 million and ¥79,552 million were recognized for the fiscal years ended March 31, 2016 and 2015 respectively, whereas previously recognized impairment charges on loans and advances amounting to ¥25,806 million were reversed for the fiscal year ended March 31, 2014.

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.

 

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The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Our financial assets and liabilities measured at fair value are mostly valued based on quoted prices 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 the fair value at the trade date, which is measured using a valuation technique with significant unobservable inputs, differs from the transaction price, any gain or loss on the trade date is adjusted to be deferred. Management judgment is required to determine whether significant unobservable inputs exist in the valuation technique.

The financial assets and liabilities are classified into one of three levels within a fair value hierarchy based on the inputs used in the fair value measurement. The three levels of the fair value hierarchy are as follows:

 

   

Level 1. Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date;

 

   

Level 2. Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

 

   

Level 3. Significant unobservable inputs for the asset or liability.

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 carried at fair value by using reasonably possible alternatives for the unobservable parameters in Note 43 “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.

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

 

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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 ¥29,606 million, ¥10,586 million and ¥11,531 million for the fiscal years ended March 31, 2016, 2015 and 2014, 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, 2016, 2015 and 2014, impairment losses on goodwill were ¥1,124 million, nil and nil, respectively.

Provision 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 characteristics of customers, and the length of the period during which 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 ¥229,422 million and ¥166,715 million at March 31, 2016 and 2015, respectively.

 

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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. 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 arising from experience adjustments and changes in actuarial assumptions in the year, and return on plan assets excluding interest income are recognized in other comprehensive income and are never reclassified to profit or loss.

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 is recognized as assets and liabilities 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 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. The net total of assets and liabilities in the consolidated statement of financial position amounted to net assets of ¥177,112 million and ¥332,674 million at March 31, 2016 and 2015, 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 results of operations, 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 carried forward and deductible temporary differences, the actual taxable profit in the future may be less than the forecast. The deferred tax assets amounted to ¥115,314 million and ¥117,500 million in the consolidated statement of financial position at March 31, 2016 and 2015, respectively, while the net total of deferred tax assets and liabilities amounted to net liabilities of ¥220,574 million and ¥446,305 million at March 31, 2016 and 2015, respectively.

New and Amended Accounting Standards and Recent Accounting Pronouncements

See “New and Amended Accounting 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.

5.A.    OPERATING RESULTS

Under the economic and financial circumstances described in “Item 5. Operating and Financial Review and Prospects—Overview—Operating Environment,” we made a profit through our commercial banking and other financial services businesses. Our total operating income increased by ¥355,793 million from ¥3,332,433 million for the fiscal year ended March 31, 2015 to ¥3,688,226 million for the fiscal year ended March 31, 2016, primarily due to an increase in net trading income. Our net profit increased by ¥229,861 million from ¥722,961 million for the fiscal year ended March 31, 2015 to ¥952,822 million for the fiscal year ended March 31, 2016, due to the increase in total operating income described above, which was partially offset by increases in impairment charges on financial assets and operating expenses.

 

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Our total assets increased by ¥991,186 million from ¥179,181,466 million at March 31, 2015 to ¥180,172,652 million at March 31, 2016, primarily due to increases in cash and deposits with banks and loans and advances, which were partially offset by a decrease in investment securities.

Our total liabilities increased by ¥969,937 million from ¥168,160,616 million at March 31, 2015 to ¥169,130,553 million at March 31, 2016, primarily due to an increase in deposits.

Our total equity increased by ¥21,249 million from ¥11,020,850 million at March 31, 2015 to ¥11,042,099 million at March 31, 2016, primarily due to increases in retained earnings and equity attributable to other equity instruments holders, which were partially offset by a decrease in other reserves.

Operating Results

The following table presents information as to our income, expenses and net profit for the fiscal years ended March 31, 2016, 2015 and 2014.

 

     For the fiscal year ended March 31,  
     2016      2015      2014  
     (In millions, except per share data)  

Interest income

   ¥ 1,872,584       ¥ 1,782,621       ¥ 1,714,044   

Interest expense

     431,101         371,107         320,511   
  

 

 

    

 

 

    

 

 

 

Net interest income

     1,441,483         1,411,514         1,393,533   
  

 

 

    

 

 

    

 

 

 

Fee and commission income

     1,031,680         1,002,766         1,003,169   

Fee and commission expense

     131,381         129,253         127,959   
  

 

 

    

 

 

    

 

 

 

Net fee and commission income

     900,299         873,513         875,210   
  

 

 

    

 

 

    

 

 

 

Net trading income

     462,682         127,759         135,218   

Net income from financial assets at fair value through profit or loss

     12,260         22,678         58,586   

Net investment income

     375,229         371,064         332,265   

Other income

     496,273         525,905         429,541   
  

 

 

    

 

 

    

 

 

 

Total operating income

     3,688,226         3,332,433         3,224,353   
  

 

 

    

 

 

    

 

 

 

Impairment charges (reversals) on financial assets

     148,356         90,138         (14,275
  

 

 

    

 

 

    

 

 

 

Net operating income

     3,539,870         3,242,295         3,238,628   
  

 

 

    

 

 

    

 

 

 

General and administrative expenses

     1,706,263         1,621,897         1,522,990   

Other expenses

     538,963         505,614         428,780   
  

 

 

    

 

 

    

 

 

 

Operating expenses

     2,245,226         2,127,511         1,951,770   
  

 

 

    

 

 

    

 

 

 

Share of post-tax profit of associates and joint ventures

     31,056         18,124         19,454   
  

 

 

    

 

 

    

 

 

 

Profit before tax

     1,325,700         1,132,908         1,306,312   
  

 

 

    

 

 

    

 

 

 

Income tax expense

     372,878         409,947         414,076   
  

 

 

    

 

 

    

 

 

 

Net profit

   ¥ 952,822       ¥ 722,961       ¥ 892,236   
  

 

 

    

 

 

    

 

 

 

Profit attributable to:

        

Shareholders of Sumitomo Mitsui Financial Group, Inc.

   ¥ 843,920       ¥ 614,070       ¥ 766,388   

Non-controlling interests

     106,129         108,891         125,848   

Other equity instruments holders

     2,773         —           —     

Earnings per share:

        

Basic

   ¥ 617.25       ¥ 449.13       ¥ 560.97   

Diluted

     616.83         448.86         560.68   

 

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Fiscal Year Ended March 31, 2016 Compared to Fiscal Year Ended March 31, 2015

Total operating income increased by ¥355,793 million, or 11%, from ¥3,332,433 million for the fiscal year ended March 31, 2015 to ¥3,688,226 million for the fiscal year ended March 31, 2016, primarily due to increases in net trading income of ¥334,923 million. Although impairment charges on financial assets increased, net operating income also increased by ¥297,575 million from ¥3,242,295 million for the fiscal year ended March 31, 2015 to ¥3,539,870 million for the fiscal year ended March 31, 2016, due to the increase in total operating income described above.

Net profit increased by ¥229,861 million from ¥722,961 million for the fiscal year ended March 31, 2015 to ¥952,822 million for the fiscal year ended March 31, 2016, as a result of the increase in net operating income described above, which was partially offset by increases in general and administrative expenses and other expenses.

Fiscal Year Ended March 31, 2015 Compared to Fiscal Year Ended March 31, 2014

Total operating income increased by ¥108,080 million, or 3%, from ¥3,224,353 million for the fiscal year ended March 31, 2014 to ¥3,332,433 million for the fiscal year ended March 31, 2015, primarily due to increases in net investment income of ¥38,799 million and other income of ¥96,364 million as discussed in detail below. Although impairment charges on financial assets increased, net operating income also increased by ¥3,667 million from ¥3,238,628 million for the fiscal year ended March 31, 2014 to ¥3,242,295 million for the fiscal year ended March 31, 2015, due to the increase in total operating income described above.

Net profit decreased by ¥169,275 million from ¥892,236 million for the fiscal year ended March 31, 2014 to ¥722,961 million for the fiscal year ended March 31, 2015, as a result of increases in general and administrative expenses and other expenses.

 

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Net Interest Income

The following tables show the average balances of our statement of financial position items, related interest income, interest expense, net interest income and average rates for the fiscal years ended March 31, 2016, 2015 and 2014.

 

    For the fiscal year ended March 31,  
    2016     2015     2014  
    Average
balance(3)
    Interest
income
    Average
rate
    Average
balance(3)
    Interest
income
    Average
rate
    Average
balance(3)
    Interest
income
    Average
rate
 
    (In millions, except percentages)  

Interest-earning assets:

                 

Interest-earning deposits with other banks:

                 

Domestic offices

  ¥ 768,976      ¥ 4,771        0.62   ¥ 741,738      ¥ 4,548        0.61   ¥ 609,023      ¥ 2,807        0.46

Foreign offices

    5,786,836        35,701        0.62     5,892,983        37,348        0.63     6,027,100        34,521        0.57
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    6,555,812        40,472        0.62     6,634,721        41,896        0.63     6,636,123        37,328        0.56
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Call loans and bills bought:

                 

Domestic offices

    147,992        861        0.58     226,409        1,177        0.52     273,903        1,583        0.58

Foreign offices

    967,442        20,967        2.17     972,643        17,429        1.79     1,154,049        16,559        1.43
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    1,115,434        21,828        1.96     1,199,052        18,606        1.55     1,427,952        18,142        1.27
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Reverse repurchase agreements and cash collateral on securities borrowed:

                 

Domestic offices

    6,675,810        10,763        0.16     4,766,205        7,875        0.17     3,749,260        7,339        0.20

Foreign offices

    741,623        11,248        1.52     726,427        9,146        1.26     419,274        7,631        1.82
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    7,417,433        22,011        0.30     5,492,632        17,021        0.31     4,168,534        14,970        0.36
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Held-to-maturity investments(1):

                 

Domestic offices

    2,964,539        12,880        0.43     4,086,502        20,509        0.50     5,238,921        30,303        0.58
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    2,964,539        12,880        0.43     4,086,502        20,509        0.50     5,238,921        30,303        0.58
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Available-for-sale financial assets(1):

                 

Domestic offices

    10,878,176        38,701        0.36     10,385,945        32,703        0.31     12,119,698        35,539        0.29

Foreign offices

    2,425,249        33,331        1.37     2,250,294        29,282        1.30     1,780,684        19,956        1.12
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    13,303,425        72,032        0.54     12,636,239        61,985        0.49     13,900,382        55,495        0.40
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Loans and advances(2):

                 

Domestic offices

    63,177,259        1,091,538        1.73     62,005,587        1,099,119        1.77     61,524,516        1,138,102        1.85

Foreign offices

    26,272,983        611,823        2.33     23,292,666        523,485        2.25     19,553,229        419,704        2.15
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    89,450,242        1,703,361        1.90     85,298,253        1,622,604        1.90     81,077,745        1,557,806        1.92
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-earning assets:

                 

Domestic offices

    84,612,752        1,159,514        1.37     82,212,386        1,165,931        1.42     83,515,321        1,215,673        1.46

Foreign offices

    36,194,133        713,070        1.97     33,135,013        616,690        1.86     28,934,336        498,371        1.72
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

  ¥ 120,806,885      ¥ 1,872,584        1.55   ¥ 115,347,399      ¥ 1,782,621        1.55   ¥ 112,449,657      ¥ 1,714,044        1.52
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

 

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    For the fiscal year ended March 31,  
    2016     2015     2014  
    Average
balance(3)
    Interest
expense
    Average
rate
    Average
balance(3)
    Interest
expense
    Average
rate
    Average
balance(3)
    Interest
expense
    Average
rate
 
    (In millions, except percentages)  

Interest-bearing liabilities:

                 

Deposits:

                 

Domestic offices

  ¥ 78,458,170      ¥ 48,032        0.06   ¥ 74,397,836      ¥ 49,356        0.07   ¥ 72,376,165      ¥ 48,446        0.07

Foreign offices

    22,838,530        154,280        0.68     21,263,919        116,211        0.55     17,014,587        91,944        0.54
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    101,296,700        202,312        0.20     95,661,755        165,567        0.17     89,390,752        140,390        0.16
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Call money and bills sold:

                 

Domestic offices

    2,199,407        1,524        0.07     2,040,724        1,504        0.07     1,497,244        1,222        0.08

Foreign offices

    663,310        4,059        0.61     877,127        2,510        0.29     651,839        2,261        0.35
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    2,862,717        5,583        0.20     2,917,851        4,014        0.14     2,149,083        3,483        0.16
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Repurchase agreements and cash collateral on securities lent:

                 

Domestic offices

    7,172,312        8,582        0.12     5,584,584        6,091        0.11     4,167,460        4,558        0.11

Foreign offices

    2,009,593        6,523        0.32     1,455,125        3,829        0.26     990,721        2,989        0.30
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    9,181,905        15,105        0.16     7,039,709        9,920        0.14     5,158,181        7,547        0.15
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Borrowings:

                 

Domestic offices

    10,251,890        56,353        0.55     9,170,288        54,915        0.60     5,879,723        50,833        0.86

Foreign offices

    823,446        15,850        1.92     790,516        16,122        2.04     787,217        17,433        2.21
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    11,075,336        72,203        0.65     9,960,804        71,037        0.71     6,666,940        68,266        1.02
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Debt securities in issue:

                 

Domestic offices

    7,999,705        120,285        1.50     7,000,273        109,960        1.57     6,223,653        92,481        1.49

Foreign offices

    3,044,714        14,887        0.49     2,819,687        9,829        0.35     2,355,748        7,636        0.32
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    11,044,419        135,172        1.22     9,819,960        119,789        1.22     8,579,401        100,117        1.17
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Other interest-bearing liabilities:

                 

Domestic offices

    93,104        676        0.73     96,873        731        0.75     90,049        689        0.77

Foreign offices

    1,960        50        2.55     3,025        49        1.62     2,898        19        0.66
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    95,064        726        0.76     99,898        780        0.78     92,947        708        0.76
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-bearing liabilities:

                 

Domestic offices

    106,174,588        235,452        0.22     98,290,578        222,557        0.23     90,234,294        198,229        0.22

Foreign offices

    29,381,553        195,649        0.67     27,209,399        148,550        0.55     21,803,010        122,282        0.56
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

  ¥ 135,556,141      ¥ 431,101        0.32   ¥ 125,499,977      ¥ 371,107        0.30   ¥ 112,037,304      ¥ 320,511        0.29
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Net interest income and interest rate spread

    ¥ 1,441,483        1.23     ¥ 1,411,514        1.25     ¥ 1,393,533        1.23
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

 

(1) Taxable investment securities and non-taxable investment securities are not disclosed separately because the aggregate effect of these average balances and interest income would not be material. In addition, the yields on tax-exempt obligations have not been calculated on a tax equivalent basis because the effect of such calculation would not be material.
(2) Loans and advances include impaired loans and advances. The amortized portion of net loan origination fees (costs) is included in interest income on loans and advances.
(3) Average balances are generally based on a daily average. Weekly, month-end or quarter-end averages are used for certain average balances where it is not practical to obtain applicable daily averages. The allocations of amounts between domestic and foreign are based on the location of the office.

 

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The following tables show changes in our interest income, interest expense and net interest income based on changes in volume and changes in rate for the fiscal year ended March 31, 2016 compared to the fiscal year ended March 31, 2015, and those for the fiscal year ended March 31, 2015 compared to the fiscal year ended March 31, 2014.

 

     Fiscal year ended March 31, 2016
compared to

fiscal year ended March 31, 2015
Increase / (decrease)
    Fiscal year ended March 31, 2015
compared to

fiscal year ended March 31, 2014
Increase / (decrease)
 
     Volume     Rate     Net change     Volume     Rate     Net change  
     (In millions)  

Interest income:

            

Interest-earning deposits with other banks:

            

Domestic offices

   ¥ 168      ¥ 55      ¥ 223      ¥ 690      ¥ 1,051      ¥ 1,741   

Foreign offices

     (663     (984     (1,647     (779     3,606        2,827   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (495     (929     (1,424     (89     4,657        4,568   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Call loans and bills bought:

            

Domestic offices

     (443     127        (316     (258     (148     (406

Foreign offices

     (94     3,632        3,538        (2,845     3,715        870   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (537     3,759        3,222        (3,103     3,567        464   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reverse repurchase agreements and cash collateral on securities borrowed:

            

Domestic offices

     3,080        (192     2,888        1,837        (1,301     536   

Foreign offices

     195        1,907        2,102        4,379        (2,864     1,515   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     3,275        1,715        4,990        6,216        (4,165     2,051   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held-to-maturity investments:

            

Domestic offices

     (5,090     (2,539     (7,629     (6,117     (3,677     (9,794
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (5,090     (2,539     (7,629     (6,117     (3,677     (9,794
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Available-for-sale financial assets:

            

Domestic offices

     1,582        4,416        5,998        (5,262     2,426        (2,836

Foreign offices

     2,347        1,702        4,049        5,785        3,541        9,326   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     3,929        6,118        10,047        523        5,967        6,490   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans and advances:

            

Domestic offices

     20,525        (28,106     (7,581     8,841          (47,824     (38,983

Foreign offices

     68,923        19,415        88,338        83,406        20,375        103,781   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     89,448        (8,691     80,757        92,247        (27,449        64,798   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income:

            

Domestic offices

     19,822        (26,239     (6,417     (269     (49,473     (49,742

Foreign offices

       70,708           25,672           96,380           89,946        28,373        118,319   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   ¥ 90,530      ¥ (567   ¥ 89,963      ¥ 89,677      ¥ (21,100   ¥ 68,577   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Fiscal year ended March 31, 2016
compared to
fiscal year ended March 31, 2015

Increase / (decrease)
    Fiscal year ended March 31, 2015
compared to
fiscal year ended March 31, 2014

Increase / (decrease)
 
     Volume     Rate     Net change     Volume     Rate     Net change  
     (In millions)  

Interest expense:

            

Deposits:

            

Domestic offices

   ¥ 2,730      ¥ (4,054   ¥ (1,324   ¥ 1,415      ¥ (505   ¥ 910   

Foreign offices

     9,149        28,920        38,069        23,342        925        24,267   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     11,879        24,866        36,745        24,757