Risk Management

Comprehensive Risk Management

The Board of Directors approves the business operations plan proposed by the Management Committee and determines the risks acceptable to the Group in view of the Bank’s capital and profit targets to be achieved. The Bank’s risk management operations are conducted by the Management Committee, the Asset and Liability Committee, the Integrated Risk Committee, the Credit Committee and the Investment Committee. The Board of Directors is committed to maintaining appropriate corporate governance and business operations by approving material decisions of each committee and receiving regular reports on risk management.

Comprehensive Risk Management System

Risk management is the process of controlling risks associated with the Bank’s business operations within the Bank’s capital, as determined by the Board of Directors. Acknowledging the importance of risk management activities, the Aozora Group has established a basic policy on comprehensive risk management designed to properly measure and control each risk separately and the overall risk in an integrated manner. As the core components of the Group’s risk management structure, we have established a number of risk management committees that have been delegated authority by the Board of Directors to implement risk management activities, and any important matters concerning risk management are determined and implemented. The basic policy on comprehensive risk management sets out the scope of target risk categories such as credit risk, market risk and operational risk, and their definitions. The policy also defines the risk management procedures, which consist of the identification, assessment, monitoring and control of the target risks.

Capital Management System

One of the most important challenges for the Aozora Group is increasing capital efficiency while securing financial soundness. Therefore, the establishment of an appropriate capital management system is one of the top priorities.

Capital management comprises risk capital management, namely economic capital management and regulatory capital management. The objective of risk capital management is to control the Bank’s business size by allocating economic capital to individual business lines according to their characteristics and risk categories after setting certain limits on the total amount of capital from the perspective of maintaining the financial soundness of the Bank. This allocation is also carried out to continuously secure adequate capital commensurate with the risk involved. Regulatory capital management is intended to ensure the minimum required capital for regulatory capital purposes and to conduct comparative verifications against the target capital ratios.

<Internal Capital Adequacy and Assessment Process>

An internal capital adequacy and assessment process is in place to ensure the adequacy of capital reserves against risk by monitoring the total capital amount for the fiscal year and the actual risk profile.

The Group assesses its internal capital adequacy by periodically monitoring the risk capital and the risk capital usage through a comparison with capital for the year and also by conducting stress tests to estimate the Bank’s potential losses, risk and possible capital requirements in the event that economic and market environments, the conditions for assessments of credit risk, market risk, operational risk, etc., undergo stressed conditions. Aozora Bank estimates risk capital for major risks, i.e., credit, market, and operational risks, using the following methodologies.

Our approach for measuring the risk capital of credit risk is based on the concept of unexpected loss (credit value at risk). First, we estimate probability of default (PD) rates based on our internal ratings transition analyses, non-recovery rates of loss given default (LGD) by collateral type, and default correlations, and then calculate credit value at risk with a confidence level of 99.9% and a one-year holding period. The calculated credit value at risk corresponds to risk capital.
We employ the VaR approach for the measurement of risk capital for market risk. The risk capital is estimated with a confidence level of 99.9% and the holding period depends on the business characteristics and liquidity of the asset.

Our approach to estimating the risk capital for operational risk is based on both an operational risk measurement approach and a loss distribution approach. Among the operational risk measurement approaches, we adopt the Standardized Approach (TSA). Under the loss distribution approach, we estimate the risk capital for operational risk by inferring the frequency and severity of loss events based on actual loss data and scenarios assuming potential risk events. In this approach, we estimate the risk capital with a confidence level of 99.9% and a one-year holding period.

<Risk Capital Allocation>

Risk capital is allocated to business groups according to their risk tolerance and expected income with the goal of improving the profitability and efficiency of the Bank as a whole.

The Board of Directors initially determines unallocated capital, i.e., the amount of capital required for continued business growth and future capital policies that will not be allocated, and subsequently allocates credit risk capital, market risk capital, and operational risk capital (limited to the amount of capital remaining after subtraction of unallocated capital) to business groups in line with management and business strategies. Business groups are responsible for conducting operations within their risk capital allocation, and capital usage is reported approximately monthly to senior management.

New Business and New Products

A new business/product is classified and managed according to the criteria for applicability of the new business/product category and for its importance. A business or product will be classified as new if certain criteria are met. A new business or product that applies will be classified into one of two categories by its level of importance: one is for submission to the Integrated Risk Committee for approval and the other is for reporting to the committee.

The committee-led control and management system functions as a framework for the development of new business or products in an integrated manner. For the appropriate launch of a new business or product proposed by a business group, its supporting groups perform the necessary check function under the Bank’s due diligence system. The Customer Protection Committee reviews the new business or product from the perspective of customer protection.

ESG Information Index