12. Environmental issues

Due to the nature of its business activities, the Bank’s and the Group’s direct impact on the natural environment is limited to the consumption of natural resources. Indirect environmental impact involves the Bank’s provision of financing the Bank’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.

Issues relating to the Group’s environmental impact and the pro-environmental initiatives undertaken by it are described in the Management Board’s Report on the operations of the PKO Bank Polski S.A. Group for 2022 in the following chapters:

• 4 “Non-financial factors in the Bank’s strategy”,
• 5 “Key non-financial performance indicators”,
• 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/severe weather events); and
• economic transformation and climate change 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.

The impact of climate-related risk factors on the Group’s expected credit losses is potentially limited, as the Capital Group, given the relatively short duration of many bank loan portfolios, expects that the most significant implications of climate change will occur in the medium to long term, and will potentially reduce today’s 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. In the lending process for corporate 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. In assessing ESG factors, the Group takes into account, among others, the risk of climate change and the impact on the customer’s business, the possible impact of the customer on climate change, factors related to human capital or health and safety, as well as factors related to aspects of governance (including organisational culture and internal supervision).

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 classified at level 3 – generally constitute financing of business entities from industries not exposed to significant climate risk (e.g. insurance companies, developers),
• granted loans classified as level 3 – 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 classified as level 3 – 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 2022 and 2021. 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 2022 and 2021.

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 2022 and 2021.
• Taxes Climate-related issues do not affect deferred income tax assets recognized by the Group as at 31 December 2022 and 2021.
• Provisions and litigation As at 31 December 2022 and 2021, there were no proceedings involving any climate or environmental issues at the Group. In the years 2021 to 2022, the Group was not subject to administrative proceedings related to violations of environmental regulations or climate impacts that resulted in the imposition of fines.

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. Premium reserve is recognized in the amount of premium attributable to future periods. In particular, flood risk provisions as at 31 December 2022 can be estimated at PLN 8.2 million (as at 31 December 2021 – PLN 3 million) – the significant increase during the year is due to the dynamic growth of the home insurance portfolio. 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.