78. Impact of the geopolitical situation in Ukraine on the PKO Bank Polski S.A. Group

The PKO Bank Polski S.A. Group conducts activities in Ukraine through the KREDOBANK S.A. Group, ‘‘Inter-Risk Ukraina’’ spółka z dodatkową odpowiedzialnością (company with additional liability), Finansowa Kompania ‘‘Prywatne Inwestycje’’ sp. z o.o. and Finansowa Kompania “Idea Kapitał” sp. z o.o. (hereinafter “the Ukrainian companies”).

As at 31 December 2022, the Ukrainian companies are continuing to operate. As at 31 December 2022, the Group is continuing to exercise control over the Ukrainian companies and accounts for them using the acquisition accounting method in the financial statements.

Armed aggression of the Russian Federation on Ukraine have serious negative consequences for the financial system and the banking sector of Ukraine. Ukraine’s GDP fell by -15% in the first quarter of 2022, by -37%, and by -31% in the third quarter. Due to the shelling of energy infrastructure in October–December 2022, the rate of GDP decline is expected to accelerate to negative 35% in the fourth quarter. Many companies operating in the war zone have had to suspend their operations or move production to other parts of the country or abroad. Transport and logistics between regions have been hampered, infrastructure has been significantly damaged and many Ukrainian citizens have been affected by the hostilities and have left the country. All this will have long-term negative consequences for Ukraine’s economy, including its banking sector.

The warfare has adversely affected the Ukrainian banking sector through:

• disruptions to the operations of Ukrainian branches and ATMs, significant damage to or destruction of the banking infrastructure in war zones;
• an increase in the share of on-demand funds at the expense of term deposits;
• a reduction in 2022 in the loan portfolio by 3% due to a significant reduction in new lending (with the exception of loans granted by state-owned banks to strategic sectors and companies). After 10 months of 2022, the sector’s loan portfolio grew by only 1% mainly as a result of the revaluation of the foreign currency portfolio with the official UAH/USD exchange rate falling by 34% since the beginning of the year; only corporate loans in UAH increased by 2% (under the state programmes launched);
• decline in banks’ commission income due to reduced customer demand for services;
• in 2022, the banking sector maintained a profit of UAH 24.7 billion, which is 3 times less than the profit for the corresponding period of the previous year, due to a significant increase in write-downs on the credit portfolio and losses as a result of war;
• inability of some borrowers to service their loans, deterioration of loan repayments due to the closure of many businesses, loss of sources of income for individuals, forced relocation of millions of Ukrainian citizens, which translates into an increase in the allowance for expected loan losses;
• restrictions on the foreign exchange market, including foreign exchange trading;
• reduction in the banks’ equity as a result of lost revenue, material losses and impairment of a part of the loan

Nevertheless, after a significant outflow of funds from banks at the beginning of the war, liquidity in the banking system is slowly increasing. In 2022, retail deposits increased by 28% (mainly in UAH) and corporate deposits by 18% (mainly in FX).

The National Bank of Ukraine (hereinafter: “NBU”) has simplified the requirements for banks’ day-to-day operations and is not introducing new regulatory requirements. In 2022, there was no regular assessment of the financial stability of banks. The NBU has also introduced a number of amendments to the legislation governing credit risk assessment. These amendments are aimed at ensuring the timely and adequate assessment of credit risk by banks, preventing banks from losing liquidity.

Starting from 25 February 2022, during the period of martial law and 30 calendar days after its cessation or revocation, when calculating credit risk requirements, Ukrainian banks did not apply requirements concerning overdue balances and thus did not accrue default interest or other charges (effective until 29 June 2022). As of the second quarter of 2022, with the gradual recovery of the Ukrainian economy from the shock of the first days of the war, Ukrainian supervisory authorities began to reinstate the previously applicable credit risk assessment regulations. This approach is aimed at the banks and the NBU estimating the level of losses incurred and the proper planning of the banks’ capital renewal activities (the calculation of days past due for debt repayment has been reinstated, with the proviso that the number of days past due for debt repayment in the period from 25 February to 29 June inclusive will not be taken into account in the calculation). Requirements have been introduced to analyse all existing information on the status of collateral located in territories subject to warfare. If information is obtained on the loss or damage of collateral, the bank is required to take this into account in its credit risk assessment. In addition, collateral from regions under occupation or where military operations are taking place is not included in the calculation of allowances. In order to support the solvency of borrowers by encouraging banks to carry out loan restructuring, some credit risk assessment requirements have been relaxed.

The NBU has also reduced the risk weights (RWA) on unsecured consumer loans from 150% to 100%, in order to allow banks to use accumulated capital to partially cover their losses, and postponed the introduction of ICCAP regulation and higher operational capital requirements.

In addition, in order to support banks’ liquidity, the NBU removed restrictions on carrying out foreign currency swap operations with the bank’s affiliates.

High inflationary pressures in 2022 prompted the NBU to tighten monetary policy – since the beginning of martial law, the NBU had kept the discount rate at 10% per annum, but in June it sharply raised it by 15 p.p. to 25% p.p. and has kept it at that level ever since.

The share of Ukrainian companies in the results, assets and liabilities of the Group for the 12 months ended 31 December 2022 and as at 31 December 2022 (including comparatives) is presented in the note “Information on operating segments”.

The Group also monitors sanction regulations on an ongoing basis and implements them to the extent appropriate to its specific business.

The entire Group has introduced guidelines for the financing of and providing banking services to:

• customers conducting business whose business model is based on the benefits of active operation in the markets of Russia and Belarus or through significant links (e.g. economic, personal),
• customers on whom sanctions have been or can be imposed in connection with Russia’s aggression in Ukraine. Following the outbreak of the armed aggression of the Russian Federation against Ukraine, restrictions were imposed on the credit policy of Ukrainian companies of the Group (Kredobank A). Granting of new financing was mainly

limited to existing customers and was implemented through the analysis of each individual transaction by the bank’s analysts, incorporating additional criteria into the analysis process, such as:

• location of the place of business, ability to continue business during martial law and current restrictions; potential threat of hostile takeover, where the customer is registered and doing business
• credit operations are not carried out without tangible and/or intangible collateral (e.g. pledge of shares, pledge of real estate, pledge of vehicles, machinery and equipment, sureties and guarantees);
• priority is given to the financing of agricultural customers with a positive pre-war history;

In order to more precisely assess the potential impact of the war on the situation of customers and their ability to service their debts, Kredobank S.A.’s loan portfolio was divided into 4 zones according to the place of business or residence. The green zone covers regions with a low risk of conducting active war activities (47% of the loan portfolio). The yellow zone includes regions close to the occupied regions or areas where military activities were active (34% of the loan portfolio). Orange includes regions of which some of the communities are under occupation or have military activities carried out on their territory (16% of the loan portfolio). The red zone includes war or temporarily occupied areas (3% of the loan portfolio – 469 million UAH). Customers who were found to be out of business, materially reduced in business or whose assets were destroyed were deemed to meet the premise of default and were subject to additional allowances. In terms of restructuring at Kredobank S.A., several standardized programmes have been introduced for each business line since June 2022. The main part of the restructuring took place in July-September 2022. At the end of 2022, the NPL level is 14.5%.

The Ukrainian state treasury bonds in the amount of PLN 420 million, due to the increase in the country’s downgrade, were moved to Stage 2 and covered by an additional allowance.

The Group also performed an analysis of the business loans portfolio from the perspective of the customers’ exposure to the adverse effects of the military conflict in Ukraine. If we adopt a threshold of at least 5% of the turnover generated from transactions with business partners from Russia, Belarus or Ukraine, the risk-exposed portfolio in Poland amounts to approx. PLN 3.8 billion. For the purpose of the measurement of credit exposures, the Group considered the information on the scale of the Polish customers’ business relations with partners from Ukraine, Belarus and Russia, and performed an assessment of various scenarios of development of the macroeconomic situation. The exposures of these customers were classified to Stage 2 and were subject to the valuation of expected credit losses throughout their lifetime. If the probability of a customer repaying its loan liabilities was assessed as low, the exposures were reclassified to Stage 3. Retail exposures granted to Russian, Belarusian or Ukrainian nationals, which as at 31 December 2022 amounted to PLN 234 million, were reclassified by the Bank into Stage 2 and their credit risk was measured over the life of these loans

As at 31 December 2022, the value of write-downs for expected credit losses on the above-mentioned portfolios amounted to PLN 434 million.

The Group has maintained a safe level of liquidity, allowing for a quick and effective response to potential threats. During 12 months ended 31 December 2022:

• PKO Bank Polski A. monitored the cash volumes in the Bank’s branches and ATMs on an ongoing basis due to a temporarily increased interest in cash withdrawals (in response to the outbreak of the war in Ukraine) and used its best efforts to allow customers to withdraw cash.
• KREDOBANK S.A.’s liquidity position, despite the ongoing conflict in Ukraine, remained stable and secure; the company did not experience a decline in liquidity measures or significant deposit outflows; moreover, KREDOBANK S.A. was classified by the National Bank of Ukraine as a systemic bank of Ukraine (LCR of around 200%, NSFR of 150%, capital adequacy ratio of around 20%)

At the same time, in connection with the war in Ukraine, the Group formed a Support Group led by the Head of the Crisis Staff, whose tasks include preventing disruption to the critical processes of the PKO Bank Polski S.A. Group, exchange of information within the Group and coordination of the aid provided. The Bank takes actions to mitigate the threats associated with the war in Ukraine on an ongoing basis, in particular with respect to ensuring access to the Bank’s systems, cyber security and the continuity of cash services and other processes.