12. Environmental issues

The nature of the business activities means that the direct impact of the Bank and the Bank’s Group on the natural environment is limited. Indirect environmental impact involves the Bank’s provision of financing the Group’s product offering.

The Group mitigates its direct impact on the environment and adjusts its lending policies addressed to the various sectors of the economy in order to also motivate its customers to mitigate their environmental impact.

The issues associated with the Group’s environmental impact and its pro-environmental initiatives are described in the Directors’ Report of the PKO Bank Polski S.A. Group for 2023 in the following chapters:

• 13.4 Non-financial factors in the Bank’s strategy”,
• 13.5 Key non-financial performance indicators”,
• 13.7 Material topics: management and risks”, including: 13.7.6 “Environment”, 13.7.7 “Climate” and 13.7.8 “Sustainable development”.

From 2021 onwards, ESG risks have been included in the Group’s risk management strategy. For issues related to ESG risk management, see note “ESG risk management”.

This note describes the impact of climate-related factors on the specific components of the Group’s financial statement, including in particular the impact of climate risk on the measurement of the expected credit losses and concentration of credit risk.

The Group is exposed to climate risk, including:

• physical risk (e.g. risk arising from more frequent/serious weather phenomena); and
• economic transformation risk (e.g. risk associated with transition to less polluting, low-emission economy, extremization of the seasons).

The climate risk may potentially affect the estimates and assessments applied by the Group (including those used in the calculation of allowances for expected credit losses).

As detailed below, there were no significant climate-related estimates or judgements in the Group that would materially affect the values recognised in these financial statements.

Climate-related issues do not present a threat to the Group’s ability to continue in operation as a going concern in the period of 12 months after the approval of these financial statements by the Management Board for publication.

The climate risk may affect the expected cash flows from loans granted and, therefore, expose the Group to credit losses. The borrower-specific attributes, physical risk and transition risk may (individually or in combination) affect the expected cash flows, as well as the potential future economic scenarios which are taken into account in the measurement of expected credit losses.

The impact of climate-related risk factors on the expected credit losses will vary depending on the severity and duration of the anticipated climate threats, their direct and indirect impact on the borrower and the lender’s loan portfolio, and the loan portfolio duration.

For the moment, the Group does not isolate specific climate risk scenarios because the impact of climate-related risk factors on the Group’s expected loan losses is potentially limited as the Group, given the relatively short-term duration of many of its bank loan portfolios, expects the most significant effects of climate change to appear in the mid- and long-term perspective, thus potentially reducing the current impact on ECL. At the same time, it is important to monitor the rate and scale of such changes and their possible effect on the measurement of the allowances for expected credit losses. The Group is in the process of implementing internal tools and methods to assess the impact of extreme climate events on its corporate and enterprise segment customer portfolios and on its mortgage-backed portfolio. The Group pays particular attention to such elements as greenhouse gas (GHG) emission allowance prices, energy efficiency of buildings, floods and droughts.

In the lending process for corporate Customers and SME Customers evaluated with the use of the rating method, the Group each time assesses the impact of environmental, social and governance factors (ESG factors) on the Customer’s creditworthiness, and identifies credit transactions with an increased financial leverage (levered transactions). The Group also examines the impact of credit transactions on ESG and classifies them to four categories, from transactions with a positive impact on ESG to those with a material negative impact. When assessing the ESG factors, the Group takes into account such factors as the risk of climate change and its impact on the customer’s operations, potential influence of the customer on climate, factors related to human capital or health and safety, and governance factors (including the corporate culture and internal audit).

In the fair value measurement of financial instruments classified to level 3 of fair value the Group does not use unobservable data relating to climate risk:

• debt securities – generally constitute financing of business entities from industries not exposed to significant climate risk (e.g. insurance companies, developers),
• granted loans – they generally represent financing for households and their fair value is estimated by applying the discounted cash-flow method using an effective credit spread,
• not listed shares in other entities – they do not include companies from sectors which are exposed to significant climate risk.

Climate-related issues do not affect depreciation and amortization recognized by the Group as at 31 December 2023 and 2022. Moreover, climate-related factors did not cause any indications of impairment of non-financial assets and did not affect their recoverable value as at 31 December 2023 and 2022.

It should be noted, though, that the potential impact of climate change risk, understood as a sudden, rapid transformation of the economy towards lower emissions (a rapid generation change of a significant class of assets in financing) may ultimately be important for the Group’s lease entities.

• Inventories – Climate-related issues do not affect the carrying amount of the inventories held by the Group as at 31 December 2023 and 2022.
• Taxes Climate-related issues do not affect deferred income tax assets recognized by the Group as at 31 December 2023 and 2022.
• Provisions and litigation – As at 31 December 2023 and 2022, there were no proceedings involving any climate or environmental issues at the Group. In the years 2023-2022, there were no administrative proceedings relating to violations of environmental regulations or the Group’s impact on climate that would lead to any fines being imposed on the Group.

Intensification of extreme weather phenomena, including in particular the risk of flood, is a specific instance of physical risk to insurance activities. The effect of this risk on the financial results and solvency is mitigated mainly by risk selection and a properly structured reinsurance programme. Insurance companies calculate the capital requirement for catastrophic risk and analyse the stress test scenarios for flood risk.

At present, insurance companies do not have environmental taxonomy for investment assets due to the fact that they do not offer new investment products.

In the case of insurance activities (property insurance), climate risk is taken into account in the valuation of liabilities, i.e. it is taken into account in the amount of the premium. In particular, flood risk provisions as at 31 December 2023 were estimated at PLN 5 million (as at 31 December 2022 – PLN 8 million). The decrease in the provision during the year, despite the increase in the residential insurance portfolio, is due to the update of the flood model (risk reduction). The model currently used to determine the risk of flooding takes into account additional variables (e.g. storeys), the absence of which in previous years resulted in an increased valuation of the risk (precautionary approach). In addition, the reduction in valuation is due to the inclusion of lower levels of materialisation in damage for lower flood return periods (more frequent floods, with reduced impact).

Upon the occurrence of an event constituting materialization of climate risk, insurance companies also recognize provisions for losses.

In the case of life insurance activities, the said risk is not sufficiently material to allow quantification of liabilities – they are valued based on an assessment of the cumulative probability of occurrence of insured events.

The ESG measures taken by the Group’s insurance companies are described in note „ESG risk management”.