Corporate Governance

The Audit & Supervisory Board (ASB) and its members monitor and verify the execution of director duties, mainly from a legal perspective. Committees, such as the Nomination and Remuneration Committee and the Audit and Compliance Committee, both of which are mainly comprised of outside directors, are entrusted by the Board of Directors to perform supplementary supervision of representative directors and executive officers and function as a check and balance on management.

<Board of Directors>

The Board of Directors establishes important basic policies for business operations and oversees the execution of duties by executive officers entrusted with daily business operations. Moreover, the outside directors' meetings include only four outside directors and are convened multiple times throughout the year to allow for the discussion and exchange of views on topics, including Aozora’s executive structure, key business issues and the operation of the Board of Directors, from an independent outside director's perspective.

<Audit & Supervisory Board>

The Bank operates under the Audit & Supervisory Board (ASB) system. The ASB performs business and accounting audits regarding the execution of duties by directors and executive officers in accordance with relevant laws and regulations. ASB meetings are held with all ASB members attending to receive reports on important audit matters and discuss or resolve them as needed.

<Nomination and Remuneration Committee>

The Nomination and Remuneration Committee, the majority of which is comprised of outside directors, provides the Board of Directors with recommendations, including prospective candidates for Board and ASB members as well as other important employees. In addition, the Nomination and Remuneration Committee determines the remuneration of directors and executive officers and makes recommendations to each ASB member regarding their remuneration.

<Audit and Compliance Committee>

The Audit and Compliance Committee, which is comprised of outside directors, reviews the adequacy and effectiveness of matters relevant to the establishment of internal control systems, including internal and external audits, risk management, compliance, and credit audits.

<Management Committee>

For the execution of business below the Management Committee level, the Aozora Group is committed to developing proper and efficient operations through the development of internal rules and material revisions to them, enhancement of the risk management structure, and internal audits by the Internal Audit Division, in accordance with the basic policy for building the internal control system approved by the Board of Directors, the basic policy for compliance with laws and regulations, and the basic policy for risk management.
The Management Committee meets weekly and determines important matters related to the Bank's execution of daily business in accordance with the policies set forth by the Board. The Management Committee has the following sub-committees to which it delegates authority: ALM Committee, Integrated Risk Committee, Credit Committee, Investment Committee, CAPEX Committee, Customer Protection Committee and Sustainability Committee. Sub-committees are comprised of members with substantive knowledge and experience in multiple aspects of the Bank's business operations, as well as sound decision-making capabilities.

• As of July 1, 2023

Specific matters discussed in the Board of Directors meetings in FY2022 were as follows.

• Confirm progress of the previous Mid-term Plan
• Discuss formulation of the next Mid-term Plan
• Sustainability initiatives
• ALM securities portfolio management status and response policy
• Nomination of independent outside director and Audit & Supervisory Board member candidates
• Set maximum tenure period for outside directors and outside Audit & Supervisory Board members
• Integrated risk report, compliance program, Annual Internal Audit Plan
• Financial report, earnings forecast announcement, dividends
• Others

Specific matters discussed in the Nomination and Remuneration Committee meetings in FY2022 were as follows.

• Compensation plan for sustainable growth and compensation amount
• Nomination of director and executive officer candidates
• Set maximum tenure period for outside directors and outside Audit & Supervisory Board members
• CEO successor plan
• Others

Specific matters discussed in the Audit and Compliance Committee meetings in FY2022 were as follows.

• Status of internal audit
• Matters regarding integrated risk management
• Status of progress of the compliance program
• Status of asset assessment
• Others

<Basic Guidelines for Determining Remuneration for Directors, etc.>

In order to pursue its mission to "contribute to the development of society through the creation of new value-added financial services," Aozora recognizes the necessity of providing proper incentives and a work environment that allows successful and high-potential human resources to perform their duties consistently while maintaining high morale, motivation and pride based on a sound mindset. To this end, the Bank has designed a remuneration system based on the following basic guidelines

1. Remuneration framework in line with the Bank's vision
   The Bank aims to build a remuneration framework that reflects business performance in line with its objectives and values.
2. Remuneration framework appropriately reflecting the Bank's performance
   The Bank's remuneration framework is based on "pay for performance" and reflects the Bank's commitment to sustainable growth, sound risk-taking through appropriate risk management, compliance, and customer protection.
3. Remuneration framework aligned with the interests of shareholders and other stakeholders
   The Bank has adopted a remuneration framework that is consistent with the values of its shareholders and other stakeholders.
4. Effective governance in remuneration decisions
   The Bank ensures that remuneration decisions are made with full independence and transparency as well as freedom from specific influence.

<Policy on Determination of the Amount and Calculation Method of Remuneration for Directors>

In order to ensure that the process for determining individual directors’ remuneration is transparent, independent, and impartial, the Nomination and Remuneration Committee, which the Bank voluntarily established and mainly comprises outside directors entrusted by the Board of Directors, determines the amounts payable to each director in accordance with the Bank’s policy of deciding the remuneration of individual directors as approved by the Board based on the Committee’s recommendation.

In principle, the Bank pays base remuneration (fixed remuneration), bonus (performance-based remuneration), and equity compensation type stock options (non-monetary remuneration) to full-time directors and only base remuneration (fixed remuneration) to outside directors.

Base Remuneration (Fixed Remuneration)

Base remuneration, which comprises a fixed amount that varies by type of position (full-time or part-time), job title, and responsibilities, is paid on a monthly basis during the tenure of each director.
Data from an outside specialized agency is used to determine whether the level of base remuneration is appropriate.
For President and Deputy President, base remuneration is determined within a range of remuneration predetermined by the type of position while taking into consideration factors including the levels of their responsibilities and experience.

Bonus (Performance-based Remuneration)

Bonuses (performance-based remuneration) are initially set at the equivalent of 40% of the base remuneration amount (the "Base Bonus Amount"), and the Nomination and Remuneration Committee determines the exact amount of bonus for each full-time director by applying a rate within a predetermined range of 0% to 250% of the Base Bonus Amount while considering the key performance indicators of the fiscal year as shown below. Bonuses are paid within a specific period following the end of each fiscal year. Specifically, the rate and bonus amount for each director are determined primarily based on the following key performance indicators, and also in consideration of the Bank's overall performance for the relevant fiscal year.

• Achievement rates of business profit and net earnings
• Statuses of the achievement of key performance indicators (KPIs), such as ROE, capital adequacy ratio, business-related profit (Business profit + Gains/losses on stock transactions) per employee, and business-related profit RORA ((Business profit + Gains/losses on stock transactions)/Risk-weighted assets)
• Assessment of undue risk-taking and occurrence of serious compliance violations
• Implementation and introduction of initiatives and strategies from a mid- to long-term perspective, including the launch of new businesses
• Progress and achievement of sustainability initiative targets announced by the Bank

Among the aforementioned performance indicators, achievement rates of business profit and net earnings are the basic indicators for the Bank’s business results. Statuses of achievement of ROE, capital adequacy ratio, business-related profit per employee and business-related profit RORA as KPIs are key indicators for the targets in the Bank’s Mid-term Plan. The achievement rates of these indicators, therefore, are taken into account as quantitative evaluation criteria for determining bonus amounts. In order to encourage not only short-term business results but also mid- to long-term initiatives, the Bank also fully considers crucial qualitative evaluation criteria for determining bonus amounts, such as the assessment of undue risk-taking and occurrence of serious compliance violations, and the implementation/introduction of initiatives and strategies from a mid- to long-term perspective, including the launch of new businesses, as well as the progress and achievement of sustainability initiative targets announced by the Bank.

The above indicators have been updated in conjunction with the new Mid-term Plan started in FY2023. The indicators used to determine performance-based remuneration for FY2022 are stated below.

• Achievement rates of business profit and net earnings
• Statuses of the achievement of KPIs, such as over-head ratio (OHR), ROA and ROE
• Status of achievement of the capital adequacy ratio
• Assessment of undue risk-taking and occurrence of serious compliance violations
• Implementation and introduction of initiatives and strategies from a mid- to long-term perspective, including the launch of new businesses
• Progress and achievement of sustainability initiative targets announced by the Bank

The targets and results of the indicators used to determine performance-based remuneration for FY2022 are stated below. Based on these results, bonuses (performance-based remuneration) were not paid to the positions of Representative Director and President as well as Representative Director and Deputy President.

1. Profit attributable to owners of parent
2. Original earnings forecast announced at the beginning of FY2022. Figures in parentheses represent the revised forecast (as announced in our news release “Aozora Announces Revision to FY2022 Full-Year Earnings Forecast” dated January 27, 2023).
3. Business profit ROA including gains/losses on equity method investments
4. Mid-term Plan “Aozora 2022” (FY2020–22)

Equity Compensation Type Stock Options (Subscription Rights to Shares as Non-monetary Remuneration)

The Nomination and Remuneration Committee discusses and sets the proper ratio of cash remuneration to equity compensation type stock options (subscription rights to shares as non-monetary remuneration) in order for stock options to serve as a sound incentive to promote sustainable growth, and determines the exact number of stock options at the equivalent of 25% of the base remuneration based on a resolution by the Board of Directors in accordance with the Internal Regulations for Equity Compensation Type Stock Options. Equity compensation type stock options are granted within a specific period following the end of each fiscal year.

Full-time Director Remuneration Structure

<Reasons for the Board of Directors’ Judgment that Remuneration for Individual Directors in FY2022 was in Accordance with the Above Policy>

The Nomination and Remuneration Committee determined the details of remuneration for individual directors from several perspectives, including an analysis of business target achievements and each director’s contribution to the Bank’s business operations, while ensuring consistency with its policy of determining remuneration. The Board of Directors respected such determination while judging that it was made in accordance with the determination policy.

<Policy on Determination of the Amount and Calculation Method of Remuneration for ASB Members>

ASB members discuss and determine their individual remuneration amounts in consideration of deliberations and proposals made at the Nomination and Remuneration Committee. ASB members only receive base remuneration (fixed remuneration), which is paid on a monthly basis during their tenure in accordance with the policy below.

Base Remuneration (Fixed Remuneration)

Base remuneration comprises a fixed amount which is determined mainly in consideration of the type of position (full-time or part-time) and assigned audit duties as well as the details and levels of director remuneration. Data from an outside specialized agency is used to determine whether the level of base remuneration is appropriate.

<Remuneration of Directors and ASB Members (April 1, 2022 to March 31, 2023)>

1. The number and remuneration in the above table include those for one director who retired at the close of the 89th General Meeting of Shareholders on June 22, 2022.
2. No director or ASB member received a total remuneration of 100.0 million yen or more

While the banking sector continues to experience significant changes in the operating environment, the Aozora Group remains committed to sustainably increasing its corporate value. In keeping with this commitment, the Group needs to promote sound risk-taking while implementing effective risk controls through proper awareness of its business environment and potential risks. The Group has established a risk appetite framework for business management that clearly identifies the type and level of risks (risk appetite) it assumes to achieve its business strategies and financial plan.
Specifically, the Group has developed the Mid-term Plan and annual business plans by comprehensively reviewing stress test results and other factors, while recognizing the expectations of its stakeholders, including shareholders and customers, as well as changes in the external and internal environment, and then determined its profitability, balance of risk-taking and resource allocation. The Bank’s business operations based on its management plan are executed under the guidance of the Management Committee and sub-committees. These committees monitor business operations as well as review progress against the plan and the operating environment, which are also taken into account in subsequent business operations.

<Role and Function>

The Internal Audit Division (IAD) operates independently from all business groups and supporting units. To help realize the Aozora Mission to “contribute to the development of society through the creation of new value-added financial services,” the IAD objectively examines and evaluates whether the Group’s internal controls are functioning properly and effectively, and offers constructive and practical recommendations for business improvement. As of March 31, 2023, 28 employees were directly engaged in internal audits.
Internal audits are conducted in line with audit plans, which are formulated according to the Annual Internal Audit Plan approved by the Management Committee and the Board of Directors each fiscal year. When formulating the audit plan, the IAD carries out risk assessments based on the type and degree of inherent risk within business groups, supporting units and group companies as well as the status of internal controls, and determines factors such as the frequency, complexity, and deployable resources of audits.
The IAD also performs cross-sectional target audits for each business process and system audits according to the importance of risk management, as well as J-SOX audits that examine the effectiveness of internal controls related to financial reporting. In FY2022, the IAD conducted a total of 79 internal audits, which were comprised of 20 audits for business groups and supporting units, 21 cross-sectional target audits, four system audits, and 34 J-SOX audits. The IAD also carried out three follow-up audits on audit findings.

<Positioning of the IAD within the Organization>

The IAD reports directly to the Chief Executive Officer (CEO) and shares the status of the Group’s internal controls with the CEO mainly through periodic reporting. The IAD also provides an independent evaluation of internal controls by presenting individual audit results to the Management Committee monthly and a summary of the audits directly to the Audit and Compliance Committee and the Board of Directors semiannually.
In order to better fulfill its audit mission, the IAD cooperates with the Audit & Supervisory Board and its members by directly exchanging information and opinions, including sharing the aforementioned audit reports and audit schedules. Furthermore, the IAD strives to work closely with Audit & Supervisory Board members and the accounting auditor by holding periodic group audit meetings where they exchange information and opinions.

<Efforts to Improve Audit Quality and Effectiveness>

The Bank’s internal audits are conducted on a risk basis in accordance with the international standards of the Institute of Internal Auditors (IIA). In addition to an internal quality assessment conducted annually, the IAD periodically undergoes an external quality assessment by a third-party organization in order to further improve the Bank’s internal audits. In FY2022, the IAD received an internal audit quality assessment by an external organization and reflected the findings in the formulation of the new Mid-term Internal Audit Plan, and also enhanced the dual role assignment system between Aozora Bank and the audit divisions of group companies in order to strengthen group governance.
In order to improve the effectiveness of its internal audits, the IAD conducts ongoing internal and external recruitment of auditors with a high level of expertise. In addition, the IAD supports and encourages its audit members to obtain professional certifications, such as Certified Internal Auditor (CIA) and Certified Information System Auditor (CISA).

<Internal Audit System>