Notes to Consolidated Financial Statements SMFG manage country risk, SMBC also has credit limit  guidelines based on each country’s creditworthiness. — Greater understanding of actual corporate condi- tions and balancing returns and risks SMBC runs credit operations on the basic principle of  thoroughly understanding actual corporate conditions  and gaining profit commensurate with the level of  credit risk entailed, and makes every effort to improve  profit at after-cost (credit cost, capital cost and  overhead) level. — Reduction and prevention of non-performing loans On non-performing loans and potential non-performing  loans, SMBC carries out loan reviews to clarify credit  policies and action plans, enabling it to swiftly imple- ment measures to prevent deterioration of borrowers’  business situations, support business recoveries, collect  on loans, and enhance loan security. — Approaches to active portfolio management SMBC is committed to agile portfolio management,  such as using credit derivatives and selling loan claims,  to stabilize its credit portfolio. In regards to financial instruments such as invest- ments in certain funds, securitized products and credit  derivatives that indirectly retain risks related to assets  such as corporate bonds and loan claims (underlying  assets), such instruments entail market and liquidity  risks in addition to credit risk, since such instruments  are traded on the market. Credit risk management for  these instruments involving detailed analysis and evalu- ation of characteristics of underlying assets is performed  while market risk is comprehensively managed within  the framework for managing market and liquidity  risks. Moreover, guidelines have been established based  on the characteristics of each type of risk.  In regards to credit risk of derivative transactions,  the potential exposure based on the market price is  regularly calculated and properly managed. When  the counterparty is a financial institution with whom  SMBC frequently conducts derivative transactions,  measures such as a close-out netting provision, which  provide that offsetting credit exposures between the  2 parties will be combined into a single net payment  from one party to the other in case of bankruptcy or  other default event, are implemented to reduce credit  risk. SMFG manages market and liquidity risks by setting  allowable risk limits; ensuring the transparency of the  risk management process; and clearly separating front- office, middle-office, and back-office operations for a  highly efficient system of mutual checks and balances. i. Market and liquidity risk management systems At SMBC, important matters such as basic policies for  managing market and liquidity risks and risk manage- ment framework are determined by the Management  Committee and then approved by the Board of  Directors.  The aforementioned Corporate Risk Management  Concentration of risk in specific borrowers/industries/ countries could severely reduce a bank’s capital should  it materialize. SMBC therefore implements measures  to prevent concentration of credit risk in specific  industries, and control large exposures to individual  borrowers by setting guidelines for maximum loan  amounts and conducting thorough loan reviews. To  — Controlling concentration risk — Appropriate risk-taking within the scope of capital  To limit credit risks to a permissible level relative to  capital, “credit risk capital limit” has been established  for internal control purposes. Under this limit, a  general guideline and designated guidelines for real  estate finance, investment in funds and securitization  products, etc. are set for each business unit. Regular  monitoring is conducted to ensure that these guidelines  are being followed. (ii) Management of market and liquidity risks SMFG  2011 99 In addition to these, the Internal Audit Unit, operat- ing independently from the business units, audits asset  quality, credit grading accuracy, self-assessment, and  appropriateness of credit risk management system, and  reports the results directly to the Board of Directors  and the Management Committee. ii. Method of credit risk management SMBC properly manages the credit risk inherent in  individual loans and the entire portfolio by assessing  and quantifying the credit risk of each borrower/ loan using the internal rating system. In addition to  management of individual loans through credit screen- ing and monitoring, it manages the credit portfolio  as described below in order to secure and improve  the credit portfolio’s soundness and medium-term  profitability. Moreover, the Credit Risk Committee, a consultative  body straddling the business units, rounds out SMBC’s  oversight system for undertaking flexible and efficient  control of credit risk and ensuring the overall soundness  of the bank’s loan operations. The Credit Departments of Consumer Banking Unit,  Middle Market Banking Unit and other business units  play a central role in credit screening and managing  their units’ credit portfolios. Each business unit estab- lishes its credit limits based on the baseline amounts  for each borrower credit grading category. Borrowers  or loans perceived to have high credit risk undergo  intensive evaluation and administration by the unit’s  Credit Department. Moreover, the Credit Portfolio Management  Department within the Credit & Investment Planning  Department works to stabilize SMBC’s overall credit  portfolio through market transactions such as loan  securitization. In the Corporate Services Unit, the  Corporate Research Department analyzes industries  as well as investigates the borrower’s business situ- ation to detect early signs of problems. The Credit  Administration Department is responsible for formu- lating and implementing measures to reduce SMBC’s  exposures mainly to borrowers classified as potentially  bankrupt or lower.