11.4. The principles for classification of financial instruments

The Group classifies financial assets into the following categories:

• measured at amortized cost;
• measured at fair value through other comprehensive income;
• measured at fair value through profit or loss.

The Group classifies financial liabilities into the following categories:

• measured at amortized cost;
• measured at fair value through profit or loss.

Classification of financial assets as at the date of their acquisition or origin depends on the business model adopted by the Group to manage a given group of assets and the characteristics of the contractual cash flows from a single asset or group of assets. The Group identifies the following business models:

• the “held to collect” cash flows model, in which financial assets originated or acquired are held in order to collect benefits from contractual cash flows – this model is typical for lending activities;
• the “held to collect and sell” cash flows model, in which financial assets originated or acquired are held to collect benefits from contractual cash flows, but they may also be sold (frequently and in transactions of a high volume) – this model is typical for liquidity management activities;
• the residual model – other than the “held to collect” or the “held to collect and sell” cash flows model.
• business model

The business model is determined by the Group upon initial recognition of financial assets. The Group determines the business model at the level of individual groups of assets, in the context of the business area in connection with which the financial assets originated or were acquired, and is based, among other things, on the following factors:

• the method for assessing and reporting the results of the financial assets portfolio;
• the method for managing the risk associated with such assets and the principles of remunerating the persons managing such portfolios.

In the “held to collect” business model, the Group sets out the following classification criteria:

• insignificant sales (less than 5% of the portfolio), even if frequent,
• infrequent sales (no more than 1 transaction – understood as 1 sale) – occasional sales transactions during the year, even if of significant value,
• sales close to maturity (a period of no more than 5% of the remaining period to maturity).

In addition, the Group uses the criterion of „incidental sales” in the event of an increase in the level of credit risk, a change in laws or regulations – the sales are made in order to maintain the assumed level of regulatory capital, in accordance with the principles described in the strategy for managing such portfolios.

The assessment of the contractual cash flow characteristics establishes, based on a test of contractual cash flows, whether contractual cash flows are solely payments of principal and interest on the principal amount outstanding (hereinafter “SPPI”). Interest is defined as consideration for the time value of money, credit risk relating to the principal remaining to be repaid within a specified period and other essential risks and costs associated with granting financing, as well as the profit margin.

Contractual cash flow characteristics do not affect the classification of the financial asset if:

• their effect on the contractual cash flows from that asset could not be significant (de minimis characteristic); In order to confirm the de minimis characteristic, the Group calculates the percentage change in cash flows for each reporting period separately, as well as cumulatively over the life of the financial instrument. A situation where the percentage change in cash flows does not exceed the materiality threshold of 5% does not constitute a breach of the SPPI test
• they are not genuine, i.e. they affect the contractual cash flows from the instrument only in the case of occurrence of a very rare, unusual or very unlikely event (non-genuine characteristic).

In order to make such a determination, the potential impact of the contractual cash flow characteristics in each reporting period and throughout the whole life of the financial instrument is considered.

The SPPI test is performed for each financial asset in the “held to collect” or “held to collect and sell” models upon initial recognition (and for substantial modifications after subsequent recognition of a financial asset).

In the case of financial assets having characteristics associated with sustainable development (green loans, where a customer may benefit from a reduced margin upon presentation of an energy efficiency certificate), the cash flow changes are assessed taking into account the possible impact of the characteristic associated with sustainable development in every reporting period and cumulatively throughout the lending period. It is also considered whether the impact of this characteristic on contractual cash flows is associated with credit risk. If the interest is increased or decreased in consequence of an increase or a decrease in credit risk, which indicates a positive correlation between the credit margin and the credit risk level, the SPPI criteria are met.

The Group analyses, among other things, the following features of financial assets which result in the SPPI test being failed:

• leverage in the design of interest rate, understood as a multiplier higher than 1;
• a creditor’s right to participate in the profit – contractual cash flows are not only the repayment of principal and interest on the outstanding principal;
• limitation of the debtor’s liabilities (resulting in a non-recourse asset);
• early repayment and extension option contingent on a future economic event which does not relate to the agreement, particularly an event not related to a change in the borrower’s credit risk level;
• covenants providing for an increase or decrease in interest rate in line with an increase or decrease in credit risk, which reflects a negative relation between the loan margin and the level of credit risk;
• interest rates unilaterally determined by the Group (administered interest rates), if they do not approximate variable market rates.

If the qualitative assessment performed as part of the SPPI test is insufficient to determine whether the contractual cash flows are solely payments of principal and interest, a benchmark test (quantitative assessment) is performed to determine the difference between the (non-discounted) contractual cash flows and the (non discounted) cash flows that would occur should the time value of money remain unchanged (the reference level of cash flows). The Group performs benchmark tests mainly when there is a mismatch between the frequency of interest rate updates and the interest rate tenor, interest rate updates based on interest rate averaging or interest rate updates based on lagged values (e.g. the value applicable one month before the revaluation date). The materiality criterion for the difference in cash flows between the agreement being tested and the benchmark at a single scenario level was set at 5% for the sum of undiscounted cash flows over the agreement horizon and 5% for the sum of cash flows in the quarterly reporting periods.