Strengthening Corporate Governance

Fundamental Approach to Corporate Governance

Hyakugo Bank is responding rapidly to the major changes taking place in its operating environment. Strengthening corporate governance is essential to making Hyakugo Bank truly competitive. In these circumstances, we are moving to raise management efficiency, accelerate decision making and increase management transparency by strengthening the functions of the Board of Directors and the Management Committee. We have also appointed outside corporate auditors and established several committees, including the Compliance Committee. Other efforts to strengthen corporate governance include initiatives to enhance investor relations.

Corporate Governance System

1. The Board of Directors, composed of 13 directors, deliberates and makes decisions on matters stipulated by law and the Bank’s articles of incorporation, as well as fundamental management policies and other important matters. The Board also oversees directors’ execution of their duties.
2. Hyakugo Bank has adopted the corporate auditor system. The five corporate auditors, including three outside corporate auditors, attend Board of Directors meetings and other important meetings, where they listen to explanations from the directors and state their opinions concerning key issues in the Bank’s management. The corporate auditors conduct audits of directors’ execution of their duties from the standpoint of legality and appropriateness. The Board of Corporate Auditors also conducts comprehensive audits of internal control functions. In addition, the Board of Corporate Auditors secures independent officers who do not have conflicts of interest with ordinary shareholders, as required by Tokyo Stock Exchange, Inc. and Nagoya Stock Exchange, Inc., and believes that it has established a structure that enables it to adequately carry out neutral and objective management oversight functions.
3. The Management Committee consisting of executive directors has been established under the Board of Directors. It deliberates and makes decisions on important matters concerning business execution based on the policies set by the Board of Directors.
4. Hyakugo Bank has established the following committees to strengthen and enhance management.
   • The Compliance Committee to establish legal compliance measures
   • The Audit Committee to oversee the appropriateness of business execution and the effectiveness of internal audits
   • The Customer Protection Management Committee, which studies improvement and response measures to improve customer protection and convenience
   • The Finance Facilitation Committee to appropriately facilitate funding for small and medium-sized businesses
   • The Risk Management Committee to maintain sound management and assess and accurately respond to various risks
   • The IT Strategy Committee to optimize information system policies and investments
   • The Performance and Compensation Committee to raise the credibility, fairness and transparency of personnel evaluations of managers

Status of Internal Control System

Hyakugo Bank’s internal control system and framework for oversight of business execution and management are as follows. To clarify its fundamental stance regarding the internal control system in general, Hyakugo Bank has established an Internal Control System Policy.

Internal Audits and Audits by Corporate Auditors

The Internal Audit Division (31 staff members as of March 31, 2011), which reports to the Board of Directors, conducts internal audits of the Bank’s internal control functions in accordance with the basic audit plan for each fiscal year, and recommends improvements when necessary. The Board of Corporate Auditors conducts comprehensive audits of the Bank’s internal control system. The Internal Audit Committee has also been established to monitor the appropriateness of business execution and the effectiveness of internal audits, and works to strengthen and improve management.

The Board of Corporate Auditors is composed of five corporate auditors, including three outside corporate auditors. One staff member is assigned to the Staff of Corporate Auditors’ Board to support the corporate auditors and the Board of Corporate Auditors. The corporate auditors receive reports on the results of internal audits and express their opinion on the effectiveness of the audits at meetings of the Internal Audit Committee managed by the Internal Audit Division. In addition, the corporate auditors strengthen cooperation with the accounting auditor by regularly exchanging information and opinions, receiving the report of audit results, and witnessing audits by the accounting auditor as appropriate.

Outside Directors and Outside Corporate Auditors

At present, Hyakugo Bank does not appoint outside directors, but has three outside corporate auditors. The outside corporate auditors provide advice and recommendations to help ensure the validity and fairness of decision-making by the Board of Directors. Hyakugo Bank believes that the current structure enables corporate auditors to adequately exercise their management oversight functions from a neutral and objective standpoint.

Outside corporate auditors receive reports on the results of internal audits from the Internal Audit Division and on evaluation of internal controls from the Risk Management Division, and express their opinions on matters including the effectiveness of internal audits and internal controls.

Outside corporate auditors also help to strengthen cooperation with accounting auditors in various ways, such as regularly exchanging information and opinions with them and receiving reports of audit results.

Risk Management Measures

Fundamental Risk Management Policies

With the deregulation and internationalization of the financial sector and the diversification of financial services and businesses, the risks to which banks are exposed are becoming more complex and diverse, heightening the importance of risk management. Hyakugo Bank is working to strengthen and enhance risk management. Its fundamental risk management policy is to gain an accurate understanding and awareness of each type of risk, and to establish an appropriate risk management framework to maintain the soundness and adequacy of management and secure stable income.

Comprehensive Risk Management System

Hyakugo Bank has a comprehensive system to understand and manage the risks it faces in conducting its banking operations.

Specifically, risks such as credit risk, market risk and operational risk are categorized, and a unit is designated as having principal responsibility for managing each type of risk in the course of operations. In addition, Hyakugo Bank has established the Risk Management Division, which is responsible for overall management of these risks. Moreover, the Risk Management Committee, chaired by the president, meets once a month to comprehensively gauge, evaluate and monitor the occurrence and management of each type of risk and consider risk management policies and measures.

In addition, Hyakugo Bank quantifies risks according to consistent criteria and executes comprehensive risk management that controls the amount of risk within a scope appropriate to the Bank’s operating capabilities. Based on this approach, Hyakugo Bank sets limits for the amount of credit risk, market risk and operational risk, as well as for their total combined amount, in working to both maintain sound operations and generate stable earnings.

Moreover, by conducting internal audits through auditing units that are independent from business divisions, the Bank examines the appropriateness and effectiveness of management within each of its divisions.

Credit Risk Management

One of the most important management tasks for a bank is maintaining the soundness of loans and other assets.

Hyakugo Bank has therefore implemented a credit rating system that employs consistent criteria to evaluate the credit risk of each borrower and loan, and formulates lending policies and sets interest rates taking creditworthiness into account. In addition, the Bank has established a credit policy that controls the concentration of credit in any specific company or corporate group, and strives to diversify risk associated with loans by understanding their distribution by industry, region, credit rating, credit amount and other categories from the standpoint of credit portfolio management.

Hyakugo Bank uses the Basic Indicator Approach (BIA) to calculate the capital adequacy ratio. However, given the increasing importance of risk management amid the growing diversity and complexity of financial transactions, the Bank is considering adopting the Foundation Internal Ratings-Based (FIRB) approach for a higher level of risk management.

In internal control, Hyakugo Bank uses Value at Risk (VaR) to measure credit risk in a way that includes credit concentration risk, which is not included in calculation of the capital adequacy ratio, based on a framework for integrated risk management. By managing risk within specified limits, the Bank aims to avoid overexposure and secure stable earnings.

In terms of its organizational structure, Hyakugo Bank has always clearly separated its sales promotion and credit investigation divisions to carry out rigorous assessment and control of credit risk.

For borrowers facing issues such as deteriorating business conditions, Hyakugo Bank appropriately determines management status and administers guidance for the formulation of revitalization plans as required to resolve problems and recover loans.

Market Risk and Liquidity Risk Management

The influence of changes in interest rates, foreign exchange rates, stock prices and other market movements on bank earnings has increased steadily. Consequently, Hyakugo Bank has strengthened its asset and liability management (ALM) capabilities with the objective of securing stable earnings. Specifically, the ALM Committee meets monthly to analyze the composition of assets, such as loans and securities, and liabilities, such as deposits. The Bank also has policies for hedging risk based on interest rate projections.

Hyakugo Bank handles market risk based on a framework for integrated risk management. The Bank quantifies various risks that are not included in the calculation of the capital adequacy ratio, such as interest rate risk embedded in its accounts, foreign exchange risk and stock price risk, primarily using VaR. We then control risk by setting risk limits for each type.

In its organization, Hyakugo Bank clearly separates trade execution (front office) and administrative processing (back office), and also has established a risk management department (middle office), thus creating a system of mutual checks and balances.

Hyakugo Bank deals with liquidity risk by appropriately monitoring and managing yen-denominated and foreign currency-denominated cash management, and maintains a fixed minimum level of highly liquid assets. In addition, the Bank regularly confirms how much liquidity can be procured in the market and formulates measures in advance to deal with unforeseen circumstances.

Operational Risk Management

The environment in the financial industry is undergoing constant change, including diversification of businesses, products and services, and the systemization of business processing. Therefore, Hyakugo Bank sets operational risk management rules to comprehensively manage the risks accompanying its business operations. The Operational Risk Management Committee meets every month to comprehensively evaluate and analyze these risks, and conducts Bank-wide consultation on and implementation of risk reduction measures.

Hyakugo Bank considers operational risk to encompass a wide range of risks consisting of administrative risk, systems risk, information asset risk, ethical and legal risk, personnel risk, fixed asset risk, reputation risk, and other operational risks. The Bank is working to upgrade the level of both qualitative and quantitative risk management.

Hyakugo Bank uses the standardized approach in calculating the capital adequacy ratio. However, in internal control, the Bank quantifies operational risk using VaR based on its integrated risk management framework for a higher level of risk management.

With regard to organization, a department is assigned responsibility for managing each type of risk, including administrative risk. Moreover, Hyakugo Bank has established the Operational Risk Control Division, thus creating a system of mutual checks and balances.

Compliance Measures

Compliance

Compliance has traditionally been one of the highest management priorities at Hyakugo Bank. In addition to issuing a compliance manual that states fundamental guidelines for compliance within the Bank, we have created a Compliance Committee to discuss overall compliance policies and established a Compliance Division to conduct integrated supervision and promotion of compliance.

Moreover, compliance officers are assigned to all headquarters departments, regional headquarters and branches, and we formulate a compliance program every year as a concrete action plan to proactively prevent legal infractions and check the status of compliance.

Response to Antisocial Forces

Hyakugo Bank resolutely refuses any improper requests or demands from antisocial forces, and coordinates with police and other outside specialized agencies to cut off any relationships with antisocial forces.

Management of Conflicts of Interest

In transactions that may pose a conflict of interest between Hyakugo Bank or its group companies and customers, or between customers of Hyakugo Bank or its group companies, Hyakugo Bank conducts business so as not to unfairly impair the interests of customers, in accordance with the Banking Act, the Financial Instruments and Exchange Act and other related laws and regulations.