17. Interest income and expenses

Interest income and expenses comprise interest, including premiums and discounts in respect of financial instruments measured at amortized cost and instruments measured at fair value through other comprehensive income, as well as income similar to interest income on instruments measured at fair value through profit or loss. Interest income and expenses also include fees and commissions received and paid, which are deferred using the effective interest rate and which are taken into account in the measurement of the financial instrument, including costs of remuneration of agents and intermediaries for the sale of the financial instrument, costs of employee bonuses to the extent that relate directly to selling credit products.

Interest income and expenses are recognized on an accrual basis using the effective interest rate method, which discounts the estimated future cash flows throughout the expected useful life of a financial asset or financial liability to the gross carrying amount of the financial asset or amortized cost of the financial liability, with the exception of:

• purchased or originated credit-impaired financial assets (POCI assets). Interest income on these assets is calculated on the net carrying amount using the effective interest rate, adjusted for the credit risk recognised for the entire life of the asset, with the calculation of interest income for the respective month being made for financial assets classified as POCI at the end of the previous month based on the net carrying amount calculated using the previous month’s net-to-gross ratio;
• financial assets which were not originally POCI assets, but subsequently became credit-impaired financial Interest income on these assets is calculated on the net carrying amount using the original effective interest rate from the moment of recognizing premises for impairment of the asset, with the calculation of interest income for the respective month being made for financial assets classified as stage 3 at the end of the previous month based on the net carrying amount calculated using the previous month’s net-to-gross ratio;

The calculation of the effective interest rate covers all commissions, transaction costs paid and received by the parties to the contract, and all other premiums and discounts constituting an integral part of the effective interest rate.

Interest income also includes:

• the effect of the fair value measurement of financial assets acquired as part of business combinations between subsidiaries
• the impact of the European Union Court of Justice’s ruling on consumer rights to reduce the cost of loans repaid before contractual maturity by reducing interest income, as the estimated difference between the value of the commission deferred using the effective interest rate as at the anticipated date of early repayment of the loan and on a straight-line basis, according to which the Bank is returning commission. The estimates are based on historical early repayment periods and their probability.
• effect of statutory credit holidays introduced by the Act on the crowdfunding of business ventures and on assistance for borrowers, recognised in the second half of 2022 in correspondence with the gross carrying amount of mortgage loans granted in PLN (note „Loans and advances to customers”).
• the impact of the amendment of the Act of 23 March 2017 on mortgage credit and supervision of mortgage credit intermediaries and agents (Journal of Laws of 2020, items 1027 and 2320 and of 2022, items 872 and 1488), concerning the reimbursement of the additional mortgage cost associated with waiting for the mortgage to be registered in the mortgage register, borne by the customer until the mortgage is registered in the mortgage register by deducting interest income, as the value of the estimated return of the margin for customers calculated until the date of registration of the mortgage in the mortgage register.

Due to the fact that the Group offers insurance products along with loans and advances and lease products and it is impossible to purchase from the Group an insurance product that is identical as to the legal form, conditions and economic content without purchasing a loan, an advance or a lease product, the payments received by the Group for the insurance products sold are treated as an integral part of the remuneration for the financial instruments offered.

Remuneration received and receivable by the Group for offering insurance products for the products directly associated with the financial instruments is settled using the effective interest rate method and recognized in interest income and, in the part corresponding to the performance of the agency service, if the insurer is a Group company, it is accounted for using the straight line method during the term of the insurance product and is recognized as commission income when the insurance product is sold or renewed.

Remuneration is divided into the commission portion and the interest portion based on the proportion of the fair value of the financial instrument and the fair value of the intermediation service to the sum of these two values, in accordance with the relative fair value model comprising a range of different parameters, including the average effective interest rate on the financial instrument, the average contractual and economic (actual) lending or lease period, the average insurance premium amount, the term of the insurance policy, the independent insurance agent’s commission.

The fair value of a financial instrument is measured according to the income-based approach, involving the conversion of future cash flows to their present value using a discount rate consisting of a risk-free rate determined in relation to the average yield on 5-year and 10-year bonds in the past year, the risk premium determined in relation to the annual costs of credit risk and exceeding the credit risk premium, which reflects all other factors that the market participants would take into account in the fair value measurement under the current circumstances.

On the other hand, measurement of the fair value of the insurance intermediation service is based on the market approach, which consists in referring to prices and other information on identical or similar comparable market transactions.

Costs directly attributable to selling insurance products are accounted for in the same manner as the revenue, i.e. as a component of the amortized cost of a financial instrument or on a one-off basis.

The Group makes periodical estimations of the remuneration amount that will be recoverable in the future due to the early termination of the insurance contract based on historical data on premiums collected and refunds made. The provision for future returns, according to the relative fair value model, is allocated to the financial instrument and recognised as a deduction from its gross carrying amount and to the insurance service – recognised under provisions.

The Group reviews the correctness of the adopted parameters used in the relative fair value model and the ratio of provisions for refunds whenever the Bank becomes aware of significant changes in this respect, at least once a year.

During the course of a working day, the Group may use funds from the mandatory reserve accounts for ongoing payments, on the basis of an instruction submitted to the National Bank of Poland (NBP). However, the Bank must ensure that the average monthly balance on this account complies with the requirements set in the mandatory reserve declaration.