3a. Impairment of financial assets

The assessment of impairment of financial assets in accordance with IFRS 9 requires estimates and assumptions, especially in the areas of estimates of the value and timing of future cash flows, the value of collaterals established, or the assessment of a significant increase in credit risk.

The assessment of impairment in accordance with IFRS 9 covers financial assets measured at amortised cost and financial assets measured at fair value through other comprehensive income as well as loan commitments. The recognition of expected credit losses depends on the change in the level of credit risk recorded since the moment of initial recognition of the financial asset. Financial assets are subject to the assessment as to whether there are any events of default.

The requirements of IFRS 9 relating to impairment are based on the model of expected credit loss.

Financial instruments subject to the assessment in terms of impairment are classified into one of three stages based on the assessment of changes in credit quality observed since initial recognition:

Stage 1: An allowance due to expected credit losses in 12-month horizon

If the credit risk did not increase significantly from the date of the initial recognition, and the event of default did not occur from the moment of granting the financial instrument, the Bank recognizes an allowance for the expected credit loss within the next 12-month horizon.

Stage 2: An allowance due to expected credit losses for the entire lifetime – no event of default identified

In the case of financial instruments, whose credit risk has increased significantly since the moment of their initial recognition, but no event of default occurred, an impairment allowance is created for the entire remaining financing period, considering the probability of the occurrence of the event of default.

Stage 3: An allowance due to expected credit losses for the entire lifetime – event of default

In the case of financial instruments for which the event of default occurred, an allowance for the expected credit loss is created for the entire remaining financing period.

In order to assess whether there has been a significant increase in credit risk since the initial recognition of the financial instrument (Stage 2), the Bank compares the risk of default during the expected period of financing granted as at the balance sheet date and the date of initial recognition. For this purpose, the Bank applies an internal credit risk rating system, information on delay in repayments (over 30 days of delay) and information from internal credit risk monitoring systems, such as warning letters and information about restructuring.

For exposures classified as Stage 2, if in subsequent periods the credit quality of the financial instrument improves and previous conclusions regarding a significant increase in credit risk since initial recognition are reversed, the exposure is reclassified from Stage 2 to Stage 1 and the allowance for expected credit losses for these financial instruments is calculated over a 12-month horizon.

For the purpose of identifying exposures eligible for Stage 3, the Bank uses a single definition of defaulted exposures and a definition of impaired exposures, and classification is based on the principles of the default triggers.

The principal event of default is a delay in repayment of more than 90 days (or more than 30 days for exposures with granted facilities) of a material amount of a past due credit obligation. In addition, other indications are taken into account, including in particular:

• restructuring,
• granting of a facility where the exposure is granted a facility or restructured,
• granting of a facility without significant economic loss where at least one of the following conditions is met
  • a large lump sum payment towards the end of the repayment schedule;
  • irregular repayment schedule, with significantly lower payments at the beginning of the repayment schedule;
  • significant grace period at the beginning of the repayment schedule;
  • exposures to an obligor that are subject to distress restructuring on more than one occasion.
• suspicion of fraud (including economic crime or any other criminal offence related to the credit exposure),
• information has been received about the submission of an application for restructuring proceedings within the meaning of the Act on Restructuring Law,
• filing of an application for commencing enforcement proceedings by the Banks or becoming aware of the fact that enforcement proceedings against the debtor are being conducted in the amount which, in the opinion of the Bank, may result in the loss of creditworthiness,
• becoming aware of the fact of filing of an application for declaring the debtor bankrupt (liquidation, consumer), putting the debtor into liquidation, dissolution or cancellation of the company, appointment of a curator, appointment of a receiver over the debtor’s activity,
• filing of an application for bankruptcy proceedings, a declaration of bankruptcy or becoming aware of the dismissal of the bankruptcy application due to the fact that the debtor’s assets are insufficient or sufficient only to meet the costs of the bankruptcy proceedings,
• termination of the credit agreement,
• submission by the Bank of an application to initiate enforcement proceedings against the customer,
• granting of a public moratorium,
• customer disputing the on-balance sheet credit exposure through legal proceedings,
• financial difficulties identified during the customer monitoring/review process or on the basis of information obtained from the customer in the course of other activities,
• significant deterioration in customer rating.

In determining the materiality level of a past due credit obligation, the Bank takes into account the thresholds contained in the „Regulation of the Minister of Finance, Investment and Development dated 3 October 2019 on the materiality level of a past due credit obligation”.

A past due credit commitment is considered material when both materiality thresholds are exceeded together:

• the amount of past due liabilities exceeds PLN 400 for retail exposures or PLN 2,000 for non-retail exposures, and
• the share of past due liabilities in the exposure is greater than 1%.

Accordingly, the calculation of the number of overdue days for the purpose of determining a default event starts once both of the aforementioned thresholds are exceeded.

While reclassifying the exposure from Stage 3 to Stage 2 or Stage 1, the Bank considers quarantine period, according to which a credit exposure with recognised objective trigger of impairment may only be reclassified into Stage 2 or Stage 1 if the customer has been servicing the receivable on time for a specified number of months. The required quarantine period differs depending on the customer type. Its length is determined by the Bank on the basis of historical observations which allow for determining the period after which the probability of default decreases to the level comparable to that of other exposures classified to the portfolio with no indications of impairment.

The individual valuation is performed by the Bank for individually significant financial assets, for which the event of default was identified. It consists in the individual determination of the allowance for expected credit losses. During the individual valuation, the Bank determines expected future cash flows and impairment allowance is calculated as the difference between the present value (balance sheet amount) of a financial asset which is individually significant and the value of future cash flows generated by that asset, discounted using the effective interest method. Cash flows from collateral are taken into account for purposes of estimating future cash flows.

The following assets are measured collectively:

• classified as individually insignificant;
• classified as individually significant, for which the event of default was not identified.

The value of the impairment allowance for the expected credit losses depends on, among others, the type of credit exposure, rating of the client, collateral type and value (for selected portfolios), which translate into the parameters such as the probability of default (PD) parameter, loss given default (LGD) parameter and credit conversion factor (CCF).

The amount of collective impairment allowances is determined with the application of statistical methods for defined exposure portfolios which are homogenous from the perspective of credit risk. Homogeneous exposure portfolios are defined based on, among others, customer segment and type of credit products. The criteria applied by the Bank to define homogeneous portfolios are aimed at grouping exposures so that the credit risk profile is reflected as accurately as practicable and, consequently, so as to estimate the level of allowances for the expected credit losses on financial assets as objectively and adequately as possible.

In order to adequately reflect the impact of the COVID-19 situation in the valuation of the loan portfolio, the Group monitors the loan portfolio for risks related to the epidemiological situation. In particular, when determining impairment losses, the Group takes into account the impact of macroeconomic scenarios and the specific characteristics of the portfolio of customers particularly exposed to the impact of the pandemic, including customers receiving public support and those operating in industries exposed to the risk related to COVID-19.

In 2021 due to lower than anticipated negative impact of the COVID-19 pandemic, the Group released PLN 33 724 thousand of provisions.

The amount includes an impact of macroeconomic assumption resulting in a release of PLN 155 854 thousand and additional COVID provisions created for particularly vulnerable segments of PLN 122 130 thousand.

Additional COVID provisions were created under the assumption, that materialization of negative COVID effects on the credit quality will be delayed (amongst others due to public support, which improved the financial and liquidity situation of the clients). The Group increased the level of provisions related to this factor from PLN 78 000 thousand as of EOY 2020 to PLN 200 130 thousand as of 31 December 2021. Provisions for the corporate segment where estimated based on a simulation of decline in income due to the COVID pandemic. For the Personal Finance portfolio, the provisions are based on applying shock changes to PD parameters for clients employed in sectors which were impacted by the pandemic.

Regardless of the discussed above COVID provisions, considering new hazards which include high inflation and increase of energy prices, the Group created an additional PLN 44 800 thousand of provisions. The provisions were estimated based on simulation analyses for portfolios particularly exposed to these risk factors.

In addition, in the fourth quarter of 2021, provisions of PLN 65,170 thousand were created in connection with amendments to the Code of Civil Procedure affecting expected recovery levels on the portfolio of loans to individual farmers.

The Bank implemented rules and IT solutions in line with the EBA guidelines on the application of the definition of default as set out in Article 178 of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26.06.2013 on prudential requirements for credit institutions and investment firms. A two-step approach was applied to align its operations with the requirements of the new definition of default under the EBA Guidelines. In the first stage, i.e. as at 31 December 2020, the Bank introduced relative and absolute thresholds for the determination of material past due, resulting from the Regulation of the Minister of Finance, Investment and Development of 3 October 2019 on the level of materiality of past due credit liabilities. The absolute threshold was set at PLN 400 for retail exposures and PLN 2,000 for non-retail exposures. The relative threshold was defined as the share of past due liabilities in total exposure greater than 1%.

In the second stage, i.e. as of 1 January 2021, the Bank aligned its operations with the remaining requirements of the EBA Guidelines. Significant changes introduced in connection with the implementation of the new definition of default include:

• establishing the level of recognition of default and calculation of overdue liabilities (customer or exposure level depending on the portfolio),
• changing the calculation of the number of past due days to a mechanism of continuous material past due (only repayment decreasing the past due liability below one of the two materiality thresholds will result in discontinuation of the calculation of past due days)
• the introduction of a new default trigger based on NPV loss, and
• the introduction of the concept of technical past due (not resulting in classification into default status).

As a result of the introduction of the amended rules, the change in classification and adequate recalculation of risk parameters resulted in the released allowances in the amount of PLN 20,983 thousand on a consolidated basis.

Allowances for the expected credit losses on financial assets are back-tested on a regular basis. The models of risk parameters used for purposes of estimating impairment allowances are covered by the model management process, which specifies the principles of their development, approval and monitoring (including model back-testing). Additionally, there is a validation unit in the Bank, which is independent of the owners and users of the models. The tasks of the unit include: annual validation of risk parameters considered to be significant. The process of validation covers both qualitative and quantitative approach. The process of estimating impairment allowances is subject to periodic functional control and verified independently by the Bank’s internal audit.

In order to calculate the sensitivity of the level of allowances related to the realisation of macroeconomic scenarios, the Bank used the method of changing the weights of the pessimistic, baseline and optimistic scenarios in accordance with their application consistent with IFRS 9.

The impact of particular scenarios is presented in the table below:

The sensitivity of the level of allowances results directly from the counter-cyclical nature of the calculation of weights assigned to individual macroeconomic scenarios. Counter-cyclicality is expressed in reducing the weight for the pessimistic scenario as the recession deepens, and in reducing the impact of the optimistic scenario in the event of an „overheating” of the economy.

In addition, the impact of the estimated change in the level of allowances due to scenarios of changes in risk parameters is presented below.

The European Securities and Markets Authority (ESMA) in its annual public statement, setting out the European common supervisory priorities for annual financial reports for 2021, identified climate-related issues as one of the priorities. The International Accounting Standards Board, in material published in November 2020, highlighted that certain IFRS standards require the impact of climate-related issues to be taken into account if the impact is material. When considering the need to disclose climate-related risks, the Bank takes into account the requirements for determining materiality of financial information in paragraph 7 of IAS 1. According to these requirements, the Bank should consider both quantitative factors and qualitative factors, as well as the interactions between the factors, when assessing whether or not the information is material.

In 2021, in response to the requirements of the EBA/GL/2020/06 Guideline of 29 May 2020 on lending and monitoring, the Bank developed ESG assessment questionnaires, which were implemented in the lending process. According to the timetable for the implementation of the Guidelines, in Phase I the assessment is carried out for Customers for whom new financing or an increase in financing is being processed. The purpose of the assessment is to identify any risks related to ESG factors affecting the financial position of the customers, as well as the impact of the customers’ business activities on ESG factors (double materiality principle). Environmental risks are subject to special analysis by the Bank. They may materialise through:

• physical risks related to environmental degradation, as well as climate change, including the occurrence of:

1. long-term climate change,
2. extreme weather events,

• transition (transformation) risks resulting from the need to adapt the economy to gradual climate change, in particular to the use of low-carbon and more environmentally sustainable solutions, including the occurrence of:

1. regulatory risk (changes in climate and environmental policies),
2. technological risks (a technology with a less damaging effect on the climate or the environment replaces a more damaging technology, making it outdated),
3. changes in market sentiment and social norms,

• liability risk arising from the Bank’s exposure to counterparties that could potentially be held liable for the negative impact of their activities on environmental, social and corporate governance factors.

The assessment of the impact of long-term climate change and extreme weather events on the activities carried out by customers, is taken into account by the Bank, in the process of granting and monitoring loans,  in accordance with the following systematics:

In the Bank’s view, the impact of climate and environmental risks does not materially affect the level of credit risk, so the Bank does not isolate these risks in the calculation of expected credit losses.

However, the Bank recognises that climate and environmental risks may represent a material risk to businesses and a systemic risk to the economy, so it is taking steps to collect relevant data on these risks.