26. Cost of the legal risk of mortgage loans in convertible currencies

In connection with the current legal disputes regarding loans in convertible currencies, the Group has identified a risk that the cash flows on the portfolio of mortgage loans denominated in and indexed to foreign currencies planned on the basis of schedules may not be fully recoverable and/or a liability resulting in a future outflow of funds may arise. Following the revisions to cash flow estimates, the Group reduces the gross carrying amount of mortgage loans denominated in and indexed to foreign currencies in accordance with the requirements of IFRS 9 Financial Instruments, paragraph B5.4.6, and/or recognises provisions for legal risk in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The cost of legal risk was estimated taking into account a number of assumptions which have a significant effect on the amount of the estimates recognized in the Group’s financial statements.

The Group recognizes as the decrease of the gross carrying amount of mortgage loans the effect of legal risk related to potential litigation and settlements for the portfolio of mortgage loans in convertible currencies and existing legal claims related to loan exposures recognized as at the balance sheet date (active loans) in the statement of financial position. If the estimated loss due to legal risk exceeds the gross value of the loan and for loans repaid, as well as in respect of statutory interest, the Group recognizes provisions for legal risk, in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. In accordance with IAS 37, the amount of the provision should reflect the most appropriate estimate of the expenditure required to meet the present obligation at the balance sheet date.

The costs of legal risk related to mortgage loans in convertible currencies were estimated using a statistical method taking into account the effect of customer characteristics as the sum of the products of:

• probabilities of specific outcomes of legal disputes and the amount of loss in the event of various dispute outcome scenarios, taking into account the current and expected number of court cases throughout the period of the Group’s exposure to such risk; and
• probability of the customer reaching a settlement and the amount of loss from the settlement.

In view of the judgment of the Court of Justice of the European Union (CJEU) in Case C-520/21 of 15 June 2023 concerning the possibility for consumers and banks to claim beyond the consideration provided under a loan agreement that has been declared invalid by the Court (for details see note “LEGAL CLAIMS”) and the associated additional uncertainty regarding the choice of course of action by the bank’s customers, the expected future number of disputes was statistically modelled with the introduction of expert elements reflecting the fact that the impact of the aforementioned non-recurring event will be observed only in subsequent periods.

The Group also estimates the probabilities of adverse outcomes for the actual and potential claims. In the evaluation of such probabilities, the Group uses the support of third party law firms. In the Group’s opinion, the level of estimated costs of legal risk is also affected by such factors as: duration of legal proceedings and high costs which must be incurred to initiate and conduct legal proceedings.

The Group has also taken into account, as an impact on the probability of settlements, the tax preferences of customers falling within the scope of the Regulation of the Minister of Finance of 11 March 2022 on suspending the collection of income tax on certain types of income (revenue) related to a mortgage loan granted for residential purposes, as amended by the Regulation of 20 December 2022, which is in force until 31 December 2024.

Given the significant uncertainty as to the assumptions made, the methodology of assessing losses in respect of the legal risk is periodically reviewed in the subsequent reporting periods. Uncertainty of estimates relates both to the number of future lawsuits, the court decisions in this respect and to the expected number of settlements, which can be affected in particular by changes in the judicial decisions concerning mortgage loans denominated in or indexed to foreign currencies, a change in base interest rates or a change in the PLN/CHF exchange rate.

In its judgment in Case C-520/21, the CJEU indicated, among other things, that the EU rules preclude a judicial construction of national law whereby a credit institution is entitled to demand compensation from a consumer that goes beyond the reimbursement of the principal paid for the performance of that agreement and beyond the payment of statutory default interest from the date of the call for payment. In this respect, the model’s parameters have been adjusted in line with the judgment.

In the judgment referred to above, the CJEU also indicated that, as regards analogous claims by consumers against banks, the provisions of the Directive do not preclude consumers from bringing such claims against banks, provided that the objectives of Directive 93/13 and the principle of proportionality are respected. In the Group’s opinion, on the grounds of national legislation and the principle of proportionality, the customers cannot make additional claims against the Group, primarily because they have not provided the Group with a financial service consisting in the provision of capital. Nor is it reasonable to conclude that the Group has enriched itself at the expense of the customer and the consumer has been impoverished. With the funds obtained, the customer met its housing needs and the Group bore the costs of raising the funds, making them available and servicing the loan over the years. The Group assesses that, at this stage, the likelihood of outcomes that are favourable to consumers, including a claim for additional compensation, generating a material adverse financial impact is difficult to estimate and, in addition, there are uncertainties as to how the level of such compensation to the customer should be calculated. This approach is supported by the fact that there have been no adverse court decisions for the Group relating to this issue.

The Group regularly, on a quarterly basis, monitors the model’s adequacy by comparing the actual key model parameters with the calculated values. In addition, new empirical data (more accurate or resulting from a longer observation) gradually modify or replace previous assumptions. The model is being adapted to the current settlement offer and changes made in this respect. During 2023, the Group updated the probability of signing a settlement or filing a lawsuit based on empirical data.

At the end of 2023, there were 3,599 pending court proceedings relating to loans in CHF for which the customer’s obligations to the Group had been repaid before the date of the lawsuit (representing approximately 4% of borrowers with repaid loans). The Group monitors the level of inflow of applications for repaid loans on an ongoing basis and models the level of expected loss for legal risk for these customers. Potential litigation settlement scenarios and their probability values for each litigation case are considered in the first instance. In doing so, the Bank has conservatively assumed the highest probabilities for the scenario that the loan agreement is declared invalid. To the indicated population of repaid customers, the Group makes a settlement offer in each case. The expected levels of conversion from lawsuit to settlement are included in the legal risk provision calculation model and adjusted on an ongoing basis to reflect the current situation.

In 2023, the Group recognised the cost of legal risk of PLN 5,430 million.

Starting from 4 October 2021, following a decision of 23 April 2021 of the Extraordinary General Meeting of PKO Bank Polski S.A., the Bank has been concluding settlements with consumers who concluded loan agreements or cash advance agreements with the Bank secured by mortgages and indexed to foreign currencies or denominated in foreign currencies (hereinafter: settlements with consumers).

In 2023, the Group continued to encourage customers to join the programme.

Revaluation of the loss in respect of the legal risk is associated with the effect of changes in foreign exchange rates on the part of the loss which is recognized in the convertible currency as adjustment to the gross carrying amount of loans.