Obligor grades and facility grades are reviewed once a year,  and, whenever necessary, such as when there are changes in the  credit situation.  There are also grading systems for small and medium-sized  enterprises (SME) loans, loans to individuals, and project finance  and other structured finance tailored according to the risk charac- teristics of these types of assets.  The Credit & Investment Planning Department centrally man- ages the internal rating systems, and properly designs, operates,  supervises, and validates the grading models. It validates the grad- ing models (including statistical validation) of main assets following  the procedures manual once a year, to ensure their effectiveness  and suitability.  Credit risk quantification refers to the process of estimating the  degree of credit risk of a portfolio or individual loan taking into  account not just the obligor’s probability of default (PD), but also the  concentration of risk in a specific customer or industry and the loss  impact of fluctuations in the value of collateral, such as real estate  and securities. Specifically, first, the PD by grade, loss given default (LGD),  credit quality correlation among obligors, and other parameter  values are estimated using historical data of obligors and facilities  stored in a database to calculate the credit risk. Then, based on  these parameters, we run a simulation of simultaneous default using  the Monte Carlo method to calculate our maximum loss exposure to  the estimated amount of the maximum losses that may be incurred.  Based on these quantitative results, we allocate risk capital. Risk quantification is also executed for purposes such as to  determine the portfolio’s risk concentration, or to simulate economic  movements (stress tests), and the results are used for making  optimal decisions across the whole range of business operations,  including formulating business plans and providing a standard  against which individual credit applications are assessed. At SMBC, credit assessment of corporate loans involves a variety  of financial analyses, including cash flow, to predict an enterprise’s  capability of loan repayment and its growth prospects. These quan- titative measures, when combined with qualitative analyses of indus- trial trends, the enterprise’s R&D capabilities, the competitiveness of  its products or services, and its management caliber, result in a  comprehensive credit assessment. The loan application is analyzed  in terms of the intended utilization of the funds and the repayment  schedule. Thus, SMBC is able to arrive at an accurate and fair credit  decision based on an objective examination of all relevant factors. Increasing the understandability to customers of loan conditions  and approval standards for specific borrowing purposes and loan  categories is a part of SMBC’s ongoing review of lending practices,  which includes the revision of loan contract forms with the chief aim  of clarifying lending conditions utilizing financial covenants.  (a) Credit Assessment (2) Framework for Managing Individual Loans (b) Quantification of Credit Risk ■ SMBC’s Obligor Grading System SMFG  2011 36 SMBC is also making steady progress in rationalizing its credit  assessment process. To respond proactively and  promptly to customers’ funding needs—particu- larly those of SMEs—we employ a standardized  credit risk assessment process for SMEs that  uses a credit-scoring model. With this process,  we are building a regime for efficiently marketing  our  Business Select Loan  and other SME loans.  In the field of housing loans for individuals,  we employ a credit assessment model based on  credit data amassed and analyzed by SMBC over  many years. This model enables our loan officers  to efficiently make rational decisions on housing  loan applications, and to reply to the custom- ers without delay. It also facilitates the effective  management of credit risk, as well as the flexible  setting of interest rates.  We also provide loans to individuals who  rent out properties such as apartments. The  loan applications are subjected to a precise  credit risk assessment process utilizing a risk  assessment model that factors in the projected  revenue from the rental business. The process is  also used to provide advice to such customers  on how to revise their business plans.  J1 J2 J3 J4 J5 J6 J7 J8 J9 J10 G1 G2 G3 G4 G5 G6 G7 G8 G9 G10 Domestic  (C&I), etc. Overseas  (C&I), etc. Obligor Grade (Domestic) Normal Assets Substandard Loans Doubtful Assets Bankrupt and Quasi-Bankrupt Assets Financial Reconstruction  Law Based Disclosure  Category Very high certainty of debt repayment High certainty of debt repayment Satisfactory certainty of debt repayment Debt repayment is likely but this could change in cases of  significant changes in economic trends or business  environment No problem with debt repayment over the short term, but not  satisfactory over the mid to long term and the situation could  change in cases of significant changes in economic trends or  business environment Currently no problem with debt repayment, but there are  unstable business and financial factors that could lead to debt  repayment problems Close monitoring is required due to problems in meeting loan  terms and conditions, sluggish/unstable business, or financial  problems (Of which Substandard Borrowers) Currently not bankrupt, but experiencing business difficulties,  making insufficient progress in restructuring, and highly  likely to go bankrupt Though not yet legally or formally bankrupt, has serious  business difficulties and rehabilitation is unlikely; thus,  effectively bankrupt Legally or formally bankrupt Normal Borrowers Substandard Borrowers Potentially  Bankrupt  Borrowers Borrowers  Requiring Caution Effectively  Bankrupt  Borrowers Bankrupt  Borrowers Definition Borrower Category J7R G7R