* Detailed information are described in Note 54 and 56

 The following rates were applied to determine the key EUR amounts for selected financial data:

·    for balance sheet items – average NBP exchange rate as at 31.12.2020: EUR 1 = PLN 4.6148 and as at 31.12.2019: EUR 1 = PLN 4.2585

·    for profit and loss items – as at 31.12.2020 - the rate is calculated as the average of NBP exchange rates prevailing as at the last day of each month in 2020: EUR 1 = PLN 4.4742; as at 31.12.2019 - the rate is calculated as the average of NBP exchange rates prevailing as at the last day of each month in 2019: EUR 1 = PLN 4.3018

As at 31.12.2020, FX denominated balance sheet positions were converted into PLN in line with the NBP FX table no. 255/A/NBP/2020 dd. 31.12.2020.

I.    Income statement. 6

II.   Statement of comprehensive income.. 7

III. Statement of financial position.. 8

IV. Statement of changes in equity. 9

V.   Statement of cash flows. 10

VI. Additional notes to financial statements. 11

1.      General information about issuer  11

2.      Basis of preparation of financial statements  11

3.      Risk management 48

4.      Capital management 76

5.      Net interest income  79

6.      Net fee and commission income  80

7.      Dividend income  80

8.      Net trading income and revaluation  81

9.      Gains (losses) from other financial securities  81

10.    Other operating income  81

11.    Impairment losses on loans and advances  82

12.    Employee costs  82

13.    General and administrative expenses  83

14.    Other operating expenses  83

15.    Corporate income tax  84

16.    Earnings per share  84

17.    Cash and balances with central banks  85

18.    Loans and advances to banks  85

19.    Financial assets and liabilities held for trading  86

20.    Hedging derivatives  87

21.    Loans and advances to customers  88

22.    Securitisation of assets  94

23.    Investment securities  95

24.    Investments in subsidiaries and associates  96

25.    Intangible assets  100

26.    Goodwill 101

27.    Property, plant and equipment 104

28.    Right of use assets  106

29.    Net deferred tax assets  108

30.    Assets classified as held for sale  110

31.    Other assets  110

32.    Deposits from banks  110

33.    Deposits from customers  111

34.    Subordinated liabilities  112

35.    Debt securities in issue  112

36.    Provisions for off balance sheet credit facilities  113

37.    Other provisions  113

38.    Other liabilities  114

39.    Share capital 115

40.    Other reserve capital 116

41.    Revaluation reserve  117

42.    Hedge accounting  119

43.    Sell-buy-back and buy-sell-back transaction  123

44.    Offsetting financial assets and financial liabilities  124

45.    Fair value  127

46.    Contingent liabilities  131

47.    Assets and liabilities pledged as collateral 136

48.    Information about leases  137

49.    Statement of cash flows - additional information  138

50.    Related parties  139

51.    Acquisitions and disposals of investments in subsidiaries and associates  142

52.    Employee benefits  142

53.    Share based incentive scheme  144

54.    Dividend per share  146

55.    Operating segments reporting  146

56.    Events which occurred subsequently to the end of the reporting period  147

I.              Income statement

II.           Statement of comprehensive income

III.         Statement of financial position

IV.         Statement of changes in equity

*details in Note 39

V.           Statement of cash flows

Information regarding liabilities arising from financial activities in relation to loans received, subordinated debt and the issue of debt securities are presented in Notes 32 to 35 respectively.

VI.         Additional notes to financial statements

1.   General information about issuer

Santander Bank Polska SA is a bank located in Poland, 00-854 Warszawa, al. Jana Pawła II 17, National Court Registry identification number is 0000008723, TIN os 896-000-56-73, National Official Business Register number (REGON) is 930041341.

On 7.09.2018, the District Court for Wrocław-Fabryczna in Wrocław,  VI Economic Unit of the National Court Register, entered into the register of entrepreneurs changes in the Bank’s statute resulting in, among others, the change of the Bank's name from the Bank Zachodni WBK SA to Santander Bank Polska SA.

The immediate and ultimate parent entity of Santander Bank Polska SA is Banco Santander, having its registered office in Santander, Spain.

Santander Bank Polska SA offers a wide range of banking services to individual and business customers and operates in domestic and interbank foreign markets. It also offers the following services:

·       intermediation in trading in securities,

·       leasing,

·       factoring,

·       asset/ fund management,

·       insurance distribution services,

·       trading in shares of commercial companies,

·       brokerage services.

2.   Basis of preparation of financial statements

2.1. Statement of compliance

These separate annual financial statements of Santander Bank Polska S.A. were prepared in accordance with the International Financial Reporting Standards (IFRS) as adopted by the European Union, which are applied on a consistent basis, as at 31 December 2020, in the case of matters not governed by the above Standards, in accordance with the provisions of the Accounting Act of 29 September 1994 (consolidated text: Journal of Law 2020, item 568) and related implementing acts as well as the requirements imposed on issuers whose securities are admitted to trading on regulated markets or issuers who have applied to have securities admitted to trading on regulated markets outlined in the Act of 29 July 2005 on Public Offering, on Conditions for the Introduction of Financial Instruments to the Organized Trading System and on Public Companies.

These financial statements have been approved for publication by the Management Board of Santander Bank Polska S.A. on 22 February 2021.

2.2. New standards and interpretations or changes to existing standards or interpretations which can be applicable to Santander Bank Polska S.A. and are not yet effective and have not been early adopted.

*New standards and amendments to the existing standards issued by the IASB, but not yet adopted by EU.

** For details of Interest Rate Benchmark Reform please refer to Risk Management section p. Interest Rate Benchmark Reform.

2.3. Standards and interpretations or changes to existing standards or interpretations which were applied for the first time in the accounting year 2020

2.4. Basis of preparation of financial statements

These separate financial statements have been prepared on the assumption that the company will continue as going concern in the foreseeable future, ie for a period of at least 12 months from the date on which these financial statements were prepared.

In its assessment, the Management Board considered, inter alia, the impact of the COVID-19 pandemic and has determined that it affects the valuation of assets and estimated future results, but does not create material uncertainty about the entity's ability to continue as a going concern.

Separate financial statements are presented in PLN, rounded to the nearest thousand.

These financial statements of Santander Bank Polska S.A. have been prepared in accordance with the International Financial Reporting Standards (IFRS) adopted in the European Union. Santander Bank Polska S.A. prepared the separate financial statements in accordance with following valuation rules:

The same accounting principles were applied as in the case of the separate financial statements for the period ending 31 December 2019, changes resulting from application of new standards are described in p.2.3 of these financial statements.

2.5. Use of estimates

Preparation of financial statement in accordance with the IFRS requires the management to make subjective judgements, estimations and assumptions, which affects the applied accounting principles as well as presented assets, liabilities, revenues and expenses.

The estimates and assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgements about carrying amounts of assets and liabilities that are not readily apparent from other sources.

The estimates and assumptions are reviewed on an ongoing basis. Changes to estimates are recognised in the period in which the estimate is changed if the change affects only that period, or in the period of the change and future periods if the change affects both current and future periods.

Key accounting estimates made by Santander Bank Polska S.A.

Key estimates include:

·       Allowances for expected credit losses

·       Fair value of financial instruments

·       Estimates for legal claims

·       Estimated collective provisions for risk arising from mortgage loans in foreign currencies

·       Estimates regarding reimbursement of fees related to early repaid consumer loans.

Allowances for expected credit losses in respect of financial assets

The IFRS 9 approach  is based on estimation of the expected credit loss (ECL). ECL allowances reflect an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes, the time value of money; and reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions. ECL allowances are measured at an amount equal to a 12-month ECL or the lifetime ECL, when it is deemed there has been a significant increase in credit risk since initial recognition. Accordingly, the ECL model gives rise to measurement uncertainty, especially in relation to:

·       measurement of a 12-month ECL or the lifetime ECL;

·       determination whether a significant increase in credit risk occurred;

·       determination of any forward-looking events reflected in ECL estimation, and their likelihood.

As a result, ECL allowances are estimated using the adopted model developed using many inputs and statistical techniques. Structure of the models that are used for the purpose of ECL estimation consider models for the following parameters:

·       PD - Probability of Default, i.e. the estimate of the likelihood of default over a given time horizon (12-month or lifetime);

·       LGD - Loss Given Default, i.e. the part of the exposure amount that would be lost in the event of default;

·       EAD – Exposure at Default, i.e. expectation for the amount of exposure in case of default event in a given horizon 12-month or lifetime.

Changes in these estimates and the structure of the models may have a significant impact on ECL allowances.

In accordance with IFRS 9, the recognition of expected credit losses depends on changes in credit risk level which occur after initial recognition of the exposure. The standard defines three main stages for recognising expected credit losses:

·   Stage 1 – exposures with no significant increase in credit risk since initial recognition, i.e. the likelihood of the exposure being downgraded to the impaired portfolio (Stage 3 exposures) has not increased. For such exposures, 12-month expected credit losses is recognised.

·   Stage 2 – exposures with a significant increase in credit risk since initial recognition, but with no objective evidence of impairment. For such exposures, lifetime expected credit losses is recognised.

·   Stage 3: exposures for which the risk of default has materialised (objective evidence of impairment has been identified). For such exposures, lifetime expected credit losses is recognised.

For the purpose of the collective evaluation of ECL, financial assets are grouped on the basis of similar credit risk characteristics that indicate the debtors' ability to pay all amounts due according to the contractual terms (for example, on the basis of the Bank’s credit risk evaluation or the grading process that considers asset type, industry, geographical location, collateral type, past-due status and other relevant factors). The characteristics chosen are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors' ability to pay all amounts due according to the contractual terms of the assets being evaluated. The rating/scoring systems have been internally developed and are continually being enhanced, e.g through external analysis that helps to underpin the aforementioned parameters which determine the estimates of impairment charges.

In the individual approach, the ECL charge was determined based on the calculation of the total probability-weighted impairment charges estimated for all the possible recovery scenarios, depending on the recovery strategy currently expected for the customer.

In the scenario analysis, the key strategies / scenarios used were as follows:

·   Recovery from the operating cash flows / refinancing / capital support;

·   Recovery through the voluntary liquidation of collateral;

·   Recovery through debt enforcement;

·   Recovery through systemic bankruptcy/recovery proceeding/liquidation bankruptcy;

·   Recovery by take-over of the debt / assets / sale of receivables.

In addition, for exposures classified as POCI (purchased or originated credit impaired) - i.e. purchased or arising financial assets that are impaired due to credit risk upon initial recognition - expected losses are recognized over the remaining life horizon. Such an asset is created when impaired assets are initially recognized and the POCI classification is maintained over the life of the asset.

Credit-impaired assets

Credit-impaired assets are classified as stage 3 or POCI.  A financial asset or a group of financial assets are impaired if, and only if, there was objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset and that impairment event (or events) had an impact on the estimated future cash flows of the financial asset or group of financial assets that could be reliably estimated. It may not be possible to identify a single, event that caused the impairment, rather the combined effect of several events may have caused the impairment. Objective evidence that a financial asset or group of assets was impaired includes observable data:

·   significant financial difficulties of the issuer or debtor;

·   a breach of contract, e.g. delay in repayment of interest or principal over 90 days in an amount exceeding the materiality threshold (PLN 500 for individual and small and medium-sized enterprises and PLN 3,000 for business and corporate clients);

·   the Santander Bank Polska S.A., for economic or legal reasons relating to the debtor's financial difficulty, granting to the debtor a concession that the Santander Bank Polska S.A. would not otherwise consider,  which meet any of the following criteria:

(1)    Transactions that have any amount in arrears for more than 90 days,

(2)    Transactions classified as non-performing before being classify as a Standard under special monitoring during the probation period  which: are refinanced or restructured or are past due for more than 30 days because of financial difficulties of the customer.

(3)    Transactions which include contractual clauses delaying the repayment through regular payments, such as grace periods, for more than two years for the repayment of the principal.

(4)    Transactions which include debt forgiveness, interest grace periods or where the instalments do not cover ordinary interest.

(5)    Customer’s plans and the repayment schedule based on them are threatened with current macroeconomic forecasts

(6)    Transactions that cause excess of the acceptable concessions level in debtor’s repayment

·   it becomes probable that the debtor will enter bankruptcy, recovery proceedings, arrangement or other financial reorganisation;

·   the disappearance of an active market for that financial asset because of financial difficulties;

·   observable data indicating that there was a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease  could not yet be identified with the individual financial assets, including:

(i)       adverse changes in the payment status of debtors in the Santander Bank Polska S.A.,

(ii)      national or local economic conditions that correlated with defaults on the assets in the Santander Bank Polska S.A.

·   exposures subject to statutory moratoria Shield 4.0 (The Act of June 19, 2020 on subsidies to interest on bank loans granted to entrepreneurs affected by  COVID-19) - application for moratoria by declaration of losing the source of income

Impaired exposures (stage 3) can be reclassified to stage 2 or stage 1 if the reasons for their classification to stage 3 have ceased to apply (particularly if the borrower’s economic and financial standing has improved) and a probation period has been completed (i.e. a period of good payment behavior meaning the lack of arrears above 30 days), subject to the following:

·   In the case of personal customers, the probation period is 6 months (excluding the time of grace period for statutory and non-statutory moratoria) 

·   In the case of SME customers, the probation period is 6 months, and assessment of the customer’s financial standing and repayment capacity is required in some cases. However, the exposure cannot be reclassified to stage 1 or 2 in the case of fraud, discontinuation of business, or pending restructuring/ liquidation proceedings.

·   In the case of business and corporate customers, the probation period is 3 months, and positive assessment of the financial standing is required (the Bank assesses all remaining payments as likely to be repaid as scheduled in the agreement). The exposure cannot be reclassified to stage 1 or 2 in the case of fraud, discontinuation of business, or pending restructuring/ insolvency/ liquidation proceedings.

·   Additionally, if the customer is in stage 3 and subject to the forbearance process, they may be reclassified to stage 2 not earlier than after 12 months (from the start of forbearance or from the downgrade to the NPL portfolio, whichever is later) provided that the debt is likely to be repaid in full in accordance with terms and conditions of forbearance.

New Default Definition

From January 2021, Bank is adjusting its credit risk classification policies to the new regulations: (a) Guidelines of the European Banking Authority (EBA/GL/2016/07) on the application of the definition of default and (b) the Regulation of the Minister of Finance, Investments and Development on the materiality thresholds of overdue credit obligations. The main changes are related to the calculation of days past due methodology and include:

·       simultaneous analysis of two materiality thresholds (absolute and relative) - days past due are counted only when both materiality thresholds (absolute and relative) are breached,

·       lower values of the absolute threshold compared to the current ones: PLN 400 vs. PLN 500 for retail customers and PLN 2000 vs. PLN 3000 for non-retail customers,

·       for non-retail obligors, calculation of days past due taking into account obligor’s combined exposure in Santander Bank Polska Group (excl. Santander Consumer Bank).

The implementation of the above mentioned changes will impact the classification of the customers exposures to stage 2 and stage 3 (delay in payment criteria) and hence the value of created provision.

Bank decided to include expected impact on provisions as a result of implementation New Default Definition in form of additional portfolio management provision.

A significant increase in credit risk

One of the key aspects of IFRS 9 is the definition of a significant increase in credit risk that determines the classification of an exposure into Stage 2. Santander Bank Polska S.A. has developed detailed criteria for identifying a significant increase in risk based on the following main assumptions:

·   Qualitative assumptions:

·       Implementing dedicated monitoring strategies for the customer following the identification of early warning signals that indicate a significant increase in credit risk

·       Restructuring actions connected with making concessions to the customers as a result of their difficult financial standing

·       Delay in payment as defined by IFRS 9, i.e. 30 days past due combined with the materiality threshold

·   Quantitative assumptions:

·       A risk buffer method based on the comparison of curves illustrating the probability of default over the currently remaining lifetime of the exposure based on the risk level assessment at exposure recognition and at reporting date. Risk buffer is set in relative terms for every single exposure based on its risk assessment resulting from internal models and other parameters of exposure impacting assessment of the Bank whether the increase might have significantly increased since initial recognition of the exposure  (such parameters consider types of the products, their term and structure as well as profitability). Risk buffer methodology was prepared internally and is based on the information gathered in the course of the decision and granting process.

·   Fact of being covered by aid measures related to COVID-19 (excluding exposures subject to statutory moratoria (Shield 4.0)) does not automatically result in classification into Stage 2 or Stage 3. Additional client`s risk is monitored on an ongoing basis. In order to manage credit risk following COVID-19 pandemic, management reports and early warning systems have been expanded, the most vulnerable populations are reviewed in detail.

·    In case of persistent financial difficulties, being an indicator of significant increase in credit risk, an exposure is transferred to Stage 2 (it is a separate criterion or the existing quantitative and qualitative criteria are used). 

·   When defining persistent difficulties, the Bank compares the level of risk before the pandemic with the current one, taking into account overdue payments and additional aid measures granted.

·   Additionally, the long-term impact of the COVID-19 pandemic in terms of provisions calculated using the individual approach, due to the specifics of this calculation, is reflected in the individual analysis by means of additional adjustments to the original (pre COVID) assumptions. The adjustments to the assumptions include: the probabilities of the cure scenario realization, the probabilities of the realization of operational cash flows as well as the expected recovery from the sale of tangible collateral.

·   Exposure in Stage 2 may be re-classified into Stage 1 without probation period as soon as significant increase in credit risk indicators after its initial recognition end e.g. when the following conditions are met: client`s current situation does not require constant monitoring, no restructuring actions towards exposure are taken, exposure has no payment delay over 30 days for significant amounts, no suspension of the contact due to Shield 4.0, no persistent difficulties and according to risk buffer method no risk increase occurs. 

·   For expired moratoria, the bank continues to use the definition of persistent difficulties. Subsequent aid measures granted to the clients which classified as restructuring, are a trigger for classification into stage 2.

Santander Bank Polska S.A. does not identify low credit risk exposures under IFRS 9 standard  rules, which allows to recognize 12-month expected loss even  in cease of significant increase of credit risk since initial recognition.

ECL measurement

Another key feature introduced by IFRS 9 is the approach to the estimation of risk parameters. For the purpose of estimating allowances for expected losses, Santander Bank Polska S.A. uses its own estimates of risk parameters that are based on internal models. Expected credit losses are equal to the estimated PD parameter multiplied by the estimated LGD and EAD parameters. The final value of expected credit losses is the sum of expected losses from all periods (depending on the stage, either in 12 months or in the entire lifetime) discounted using the effective interest rate. The estimated parameters are adjusted for macroeconomic scenarios in accordance with the assumptions of IFRS 9. To this end, the Bank determines the factors which affect individual asset classes to estimate an appropriate evolution of risk parameters. The Bank uses internally developed scenarios, which are updated at least every six months. The models and parameters generated for the needs of IFRS 9 are subject to model management process and periodic calibration and validation.

Determination of forward-looking events and their likelihood

Forward-looking events are reflected both in the process of estimating ECL and when determining a significant increase in credit risk, by developing appropriate macroeconomic scenarios and then reflecting them in the estimation of parameters for each scenario. The final parameter value and the ECL is the weighted average of the parameters weighted by the likelihood of each scenario. Bank uses three scenario types: the baseline scenario and two alternative scenarios, which reflect the probable alternative options of the baseline scenario: upsideand downside scenario.

In order to avoid using a highly volatile data, where forecast regarding future developments might be unsupported, scenarios of macroeconomic factors published before the pandemic start were used to calculate the expected credit losses. The impact of the pandemic is reflected in the management overlay which is described in the following section.

Additional provision covering risk resulting from COVID-19 pandemic

Santander Bank Polska S.A. monitors current economic situation and credit portfolio behaviours in relation to COVID-19 pandemic. Due to high uncertainty, mainly in the context of timing and range of potential economic deterioration, the Bank  decided to create additional provision (above the risk resulting from provisional parameters) for expected credit losses, in the form of post-model adjustment. Bank verified the level of post-model adjustment at the end of the year in the amount of PLN 80,300k  (vs PLN 108 500 accounted previously in June) . The update was made due to regular review of the risk parameters process, taking into account the current portfolio structure and actual risk profile.

Due to lack of observations, there is a potential risk that macroeconomic models developed over relatively stable historical periods may not fully reflect the economic shock properly (e.g. stronger correlation of variables, changed interpretation of variables during a crisis).

Taking into account high level of uncertainty currently surrounding the forward-looking information and associated with the development of the pandemic situation, in terms of the scale of the deterioration, its horizon and the impact of support measures taken on the individual customers’ situation, it was decided not to use new macroeconomic scenarios (including COVID-19 situation) for the purpose of IFRS9 risk parameters’ update.

However, to reflect the higher risk level that is expected to be observed for credit portfolios, it was decided to create a portfolio management provision (in form of post-model adjustment) that will cover the uncertainty associated with the impact of a pandemic not included on the level of IFRS9 risk parameters.

In line with the adopted process, in the fourth quarter the Bank has carried out a yearly review of the risk parameters. Unchanged remains reflecting forward-looking events both in the process of estimating ECL and when determining a significant increase in credit risk, by reflecting appropriate macroeconomic scenarios in the estimation of parameters for each scenario. Provision level update resulting from uncertain macroeconomic perspectives (additional to the actions

already described), was recognized in post-model adjustment and was based on a modified scenario including long-term negative impact of COVID-19 pandemic economy.

To include the effect of COVID in Expected Credit Losses Bank has decided to use a scenario reflecting a longer impact of COVID on macroeconomic factors than actually observed short term shock, yet fully recognizing the impact to the economy and expected risk.

It was prepared using a scenario where the economic shock is observed. Then, to exclude the high volatility of short term shocks to economy, convergence to the long term point was assumed.

Long Run scenario

In 2020 the COVID-19 became the main factor affecting economic outlook as the Polish government decided to close schools, leisure services, shopping centres, and international travel.  As the disease was spreading around the world, lower foreign demand also hit Poland’s exports.

After a significant drop in GDP in 2020, in 2021 a strong rebound is expected and then the economy should return to its potential growth rate somewhat above 3.0%. While the year 2020 started with an elevated inflation (4.6% in 1Q20), the lower demand was expected to lead to deceleration of price growth.

The government responded to the crisis with a fiscal stimulus, aimed at supporting companies and encouraging them not to cut jobs. Due to these actions, the general government deficit was expected to surpass 10% of GDP in 2020. At the same time, the NBP cut the reference rate by 140bp to 0.10%, introduced liquidity and bond-purchasing programmes for the banking sector.

Lower economic activity negatively affected the demand for loans in the banking system, especially in the household sector. As the government  expanded its fiscal policy markedly and the NBP  increased its balance via bond purchases, there was additional money creation in the economy. Additionally, the so-called “financial shield” by the Polish Development Fund (PFR)  boosted liquidity in the banking system (the PFR bonds were purchased by NBP on the secondary market), while limiting firms’ demand for loans at the same time. As a result, a major slowdown in loans was accompanied by a massive surge in deposits.

The tables below present the key economic indicators assumed for the long-run scenario.

Bank will include in subsequent reporting periods along with obtaining reliable information about forecasts and on the basis of observations from the behavior of individual loan portfolios, the Bank will take them into account respectively, as part of changes in the provision model or by changing the value of the estimated additional provision.

Baseline Scenario

In the following years the economic growth in Poland is expected to gradually converge towards its potential rate, which is estimated at somewhat above 3% per annum. The gradual slowdown in Poland will be supported by the expected deceleration of economic growth abroad, in particular by Brexit effects, and the drying up supply of available domestic workforce. The latter implies that the pace of economic growth is unlikely to be persistently higher than the pace of productivity growth.

Upside scenario

The upside scenario is based on the assumption that the Polish economy is markedly boosted by the fiscal stimulus in 2020, while high economic momentum is fueling wage growth, encouraging domestic population’s labour activity and securing a strong inflow of immigrant workers. Positive economic outlook is translating into elevated investment activity.

Downside scenario

The downside scenario was built under an assumption that the labour market pressure and lack of available work force discourages investment and weighs on capacity and ability to take up new orders. The scenario was designed in a way to ensure that the magnitude of the stress corresponds to the scale of moderate downturns that happened in the past two decades of history of Poland’s market economy.

The tables below present the key economic indicators arising from the respective scenarios.

Potential variability

Changes in forecasts of macroeconomic indicators may result in significant effects affecting the level of created provisions. Adoption of macroeconomic parameter estimates at only one scenario level (pessimistic or optimistic) will result in a one-off change in ECL at the level below.

The sensitivity of individual portfolios to changes in the macroeconomic environment (in terms of  COVID19 post-model adjustment) largely depends on the relationship between the default risk and market indicators. This relationship is different for different portfolios and the expected risk might be dependent on the changes in unemployment, CPI, exchange rates etc.

Based on the GDP indicator as the main factor determining the condition of the economy, Santander Bank Polska S.A.  estimates that a reduction in the target level of gross domestic production by 1pp by 2024 would translate into an increase in expected credit losses in amount PLN 14 559k.

The above analyze is made on the basis of the assumption that the remaining macroeconomic variables would retain their relation to GDP.

Significant volatility for the income statement may be reclassifications to stage 2 from stage 1. The reclassification of given percentage of exposures from stage 1 with the highest risk level to stage 2 for each type of exposure would result in an increase in ECL according to below table ( portfolio as at 31 December 2020).

The theoretical reclassification of 1% of exposures from stage 1 with the highest risk level to stage 2 for each type of exposure would result in an increase in ECL by PLN 19 200k according to the portfolio as of 31 December 2020 for Santander Bank Polska S.A. (in relation to PLN 20 100 k as at 31 December 2019).

The above estimates show expected variability of loss allowances as a result of transfers between stage 1 and stage 2, resulting in significant changes in the degree to which exposures are covered with allowances in respect of different ECL horizons.

Fair value of financial instruments, including instruments which do not meet the contractual cash flows test

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Santander Bank Polska S.A. applies a methodology for measuring the fair value of credit exposures and debt instruments  measured at fair value through profit or loss.

In the case of the instruments with distinguishable on-balance sheet and off-balance sheet components, the extent of fair value measurement will depend on the nature of the underlying exposure, and:

·   the on-balance sheet portion always will be measured at fair value;

·   the off-balance sheet portion will be measured at fair value only if at least one of the following conditions is met:

·       condition 1: the exposure has been designated as measured at fair value (option) or

·       condition 2: the exposure may be settled net in cash or through another instrument or

·       condition 3: Santander Bank Polska S.A. sells the obligation immediately after its granting  or

·       condition 4: the obligation was granted below the market conditions.

The fair value is measured with the use of valuation techniques appropriate in the circumstances and for which sufficient data are available, maximising the use of relevant observable inputs and minimising the use of unobservable inputs.

Bank applies following valuation techniques:

·   market approach – uses prices and other relevant information generated by market transactions involving identical or comparable (similar) assets, liabilities, or a group of assets and liabilities (e.g. a business unit)

·   income approach – converts future amounts (cash flows or income and expenses) to a single current (discounted) date. When the income approach is used, the fair value measurement reflects the current market expectations as to the future amounts.

Santander Bank Polska S.A. uses the income approach for fair value measurement relating to financial instruments which do not meet contractual cash flows test.

The following arguments support the use of the income approach:

·   no active market;

·   the cost approach is not used in the case of financial assets (it usually applies to property, plant and equipment and property investments).

In the case of credit exposures and debt instruments, the present value method within income approach is typically used. In this method, the expected future cash flows are estimated and discounted using a relevant interest rate. In the case of the present value method, Santander Bank Polska S.A. uses the following elements in the valuation:

·   expectations as to the future cash flows;

·   expectations as to potential changes in cash flow amounts and timing (uncertainties are inherent in cash flow estimates);

·   the time value of money, estimated using risk-free market rates;

·   the price of uncertainty risk inherent in cash flows (risk premium) and

·   other factors that market participants would take into account in the circumstances.

The present value measurement approach used by Santander Bank Polska S.A. is based on the following key assumptions:

·   cash flows and discount rates reflect the assumptions that market participants would adopt in the measurement of an asset;

·   cash flows and discount rates reflect only the factors allocated to the asset which was subject to measurement;

·   discount rates reflect the assumptions which are in line with the cash flow assumptions;

·   discount rates are consistent with the key economic factors relating to the currency in which the cash flows are denominated.

The fair value determination methodology developed by Santander Bank Polska S.A. provides for adaptation of the fair value measurement model to the characteristics of the financial asset subject to measurement. When determining the need for adaptation of the model to the features of the asset subject to measurement, Santander Bank Polska S.A. takes into account the following factors:

·   approach to the measurement (individual/ collective) given the characteristics of the instrument subject to measurement;

·   whether a schedule of payments is available; 

·   whether the asset subject to measurement is still offered by Santander Bank Polska S.A. and whether the products recently provided to customers can be a reference group for that asset.

Other significant groups of financial instruments measured at fair value are all derivatives, financial assets held within a residual business model, debt investment financial assets held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, and equity investment financial assets. These financial instruments are either measured with reference to a quoted market price for that instrument or by using a respective measurement model.

Where the fair value is calculated using financial-markets pricing models, the methodology is to calculate the expected cash flows under the terms of each specific contract and then discount these values back to a present value. These models use as their basis independently sourced market parameters including, for example, interest rate yield curves, securities and commodities prices, option volatilities and currency rates. Most market parameters are either directly observable or are implied from instrument prices.

In justified cases, for financial instruments whose carrying amount is based on current prices or valuation models, Santander Bank Polska S.A. takes into account the need to identify additional adjustments to the fair value of the counterparty credit risk.

The fair value measurement models are reviewed periodically.

A summary of the carrying amounts and fair values of the individual groups of assets and liabilities is presented in Note 43.

Estimates for legal claims

Santander Bank Polska S.A raises provisions for cases disputed in court on the basis of likelihood of unfavourable verdict and recognises them in accordance with IAS 37.

The provisions have been estimated considering the likelihood of payment.

As at  31 December 2020, Bank increased its provisions for legal claims regarding mortgage loans denominated in foreign currencies due to the increase in the number of cases in which the Bank is party to the proceedings.

Details on the value of provisions for legal claims can be found in Note 37.

Estimated collective provisions for risk arising from mortgage loans in foreign currencies

In connection with the CJEU’s ruling described in Note 46, there is an increased risk that clauses in agreements from the portfolio of mortgage loans denominated in or indexed to foreign currencies may be effectively challenged by customers. The Management Board considered the risk that the scheduled cash flows may not be fully recoverable and/or a liability may arise resulting in a future cash outflow. Thus the Bank decided to maintain additional collective provision for legal risk, in addition to provisions for individual court cases.

The collective provision, in particular the provision for mortgage loans denominated in or indexed to foreign currencies has been estimated on the basis of a specific time horizon, the likelihood of a number of events, such as finding contractual clauses abusive or losing a court case, and different scenarios for possible judgments.

The Bank has increased in 2020 its portfolio provisions by PLN 42 900k  for this risk as a result of the review and update of estimates, and will continue to monitor this risk in subsequent reporting periods. The change in estimates is related to the current state of the jurisprudence of the courts and client readiness for legal dispute. The portfolio provision as at 31 December 2020 amounts to PLN 191 900k. As at 31 December 2019  portfolio provision amounted to PLN 149 000k.

The Management Board stresses that the estimates come with significant uncertainty and may be subject to major changes in the future. A detailed description of the assumptions underpinning the calculation of collective provisions and variability analysis is presented in Note 37.

Estimates regarding reimbursement of fees related to early repaid consumer loans

Santander Bank Polska S.A. has increased in 2020 provision for potential customer claims in respect of a partial reimbursement of fees on consumer loans repaid ahead of their contractual maturity, before the 11^th September 2019, amounting to PLN 62 365k as an increase in operating cost. The change resulted from taking into account the most recent data in the estimates, and extending the scale of contracts for which the Bank reimburses the commission by including the returns process for contracts concluded after 18 December 2011. As at 31 December 2020, the provision amounted to PLN 47 968k and PLN 6 771k as at 31 December 2019.

The above provision has been estimated on the basis of product type, repayment formula, and amount of the fee to be reimbursed. The reimbursement amount is calculated as the outstanding interest payments in the periods following the overpayment to all the interest payments in the original credit period.

Bank has changed estimated future cash flows for cash loan portfolio due to early prepayments done by clients. Change in cash flows was assessed on the base of historical prepayment levels, volume and portfolio characteristics and amounted to PLN 21 305k in 2020. The decrease in cash flows was recognised as an adjustment to gross carrying amount of loan receivables and decrease in interest income.

In addition, due to early prepayments causing shorter tenors, Bank decided to adjust third party intermediary cost calculated according to EIR in respect of expected early prepayments. The adjustment amounted to PLN 35 155k, and was recognised as an adjustment to gross carrying amount of loan receivables and decrease in interest income. As at 31 December 2019 intermediary cost adjustment amounted to PLN 24 744k.

The cumulated negative effect of early partial and full repayments on the Bank's result in 2020 totaled PLN 163 864k including PLN 101 499k as a reduction in interest income, and PLN 62 365k as operating costs. In 2019 the overall impact amounted to PLN 54 744k, with PLN 24 744 k as a decrease in interest income, and PLN 30 000  as operating cost.

Potential variability

Change in client`s behavior regarding complaints may cause current provisions levels to be changed in following manner. Extension of the period for which the Bank expects consumer complaints to continue is assessed as a pessimistic scenario, whereas the shortening is regarded as optimistic.

2.6. Judgements that may significantly affect the amounts recognized in the financial statements

When applying the accounting principles, the management of Santander Bank Polska S.A., makes various judgements that may significantly affect the amounts recognized in financial statements.

Assessment whether contractual cash flows are solely payments of principal and interest

The key issue for Santander Bank Polska S.A.'s business, is to assess whether the contractual terms related to financial assets component indicate the existence of certain cash flow dates, which are only the repayment of the nominal value and interest on the outstanding nominal value.

For the purposes of this assessment, ‘principal’ is defined as the fair value of the financial asset on initial recognition and ‘interest’ is defined as consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs (e.g. liquidity risk and administrative costs), as well as a profit margin.

In assessing whether the contractual cash flows are solely payments of principal and interest, Santander Bank Polska S.A. considers the contractual terms of the instrument. This includes assessing whether the financial assets contains a contractual term that could change the timing or amount of contractual cash flows such that it would not meet this condition. In  making the assessment the Santander Bank Polska S.A. considers:

·   contingent events that would change the amount and timing of cash flows,

·   leverage features,

·   prepayment and extension terms,

·   terms that limit Santander Bank Polska S.A.’s claim to cash flows from specified assets (e.g. non-recourse asset arrangements)

·   features that modify consideration for the time value of money.

A prepayment feature is consistent with the SPPI criterion if the prepayment amount substantially represents unpaid amounts of principal and interest on the principal amount outstanding, which may include reasonable compensation for early termination of the contract.

In addition, a prepayment feature is treated as consistent with this criterion if a financial asset is acquired or originated at a premium or discount to its contractual paramount, the prepayment amount substantially represents the contractual par amount plus accrued (but unpaid) contractual interest (which may also include reasonable compensation for early termination), and the fair value of the prepayment feature is insignificant on initial recognition.

In the process of applying Santander Bank Polska S.A.’s accounting policy management assessed whether financial assets, including loan agreements, whose interest rate construction contains a multiplier greater than 1, meet classification criteria allowing their valuation at amortised cost, that is:

·   business model and

·   characteristics of contractual cash flows.

The most significant portfolio of financial assets, whose interest rate construction contained a multiplier greater than 1, includes credit cards granted until 01.08.2016, whose interest rate formula was based on 4x lombard rate and did not contain direct reference to the provisions of the Civil Code in the regard of interest cap.

This financial asset portfolio is maintained in a business model whose objective is to hold financial assets in order to collect contractual cash flows. Credit risk for these assets is the basic risk managed in portfolios, and historical analysis of frequency and volume of sales do not indicate significant sales of asset portfolios for reasons other than credit risk.

In addition, it was not found that:

·   fair value was a key performance indicator (KPI) for assessing portfolio performance for internal reporting purposes,

·   the assessment of the portfolio's results was based only on the fair value of assets in the analyzed portfolio,

·   remuneration of portfolio managers was related to the fair value of assets in the analyzed portfolio.

Whereas contractual terms related to a financial asset indicate that there are specific cash flow terms that are not solely payments of principal and interest on the principal outstanding due to the existence of a financial leverage in the construction of interest rate. It increases the variability of the contractual cash flows with the result that they do not have the economic characteristics of interest. The credit card portfolio with the above characteristics s disclosed as a portfolio measured at fair value through profit or loss.

Business Model Assessment

Business models at Santander Bank Polska S.A. are determined at a level that reflects how groups of financial assets are managed together to achieve a particular business objective. The business model does not depend on the intentions of the Santander Bank Polska S.A. management regarding a particular instrument, which is why the model is assessed at a higher level of aggregation.

The business model refers to how Santander Bank Polska S.A. manages its financial assets in order to generate cash flows. That is, the business model determines whether cash flows will result from:

·   a contract (a business model whose objective is to hold assets in order to collect contractual cash flows) 

·   the sale of financial assets (other/residual business model) or

·   from both of those sources (a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets).

The assessment of a business model  involves the analysis of qualitative and quantitative criteria (both presented in the section concerning classification of financial assets).

If Santander Bank Polska S.A. changes the business model for financial asset management, the entire portfolio of assets covered by that business model is reclassified on the level of a specific reporting segment, and the consequences arising from the change of the assessment category are recognised at a point of time in the profit and loss account or other comprehensive income.

Santander Bank Polska S.A. expects that such changes will take place rarely. They are determined by Santander Bank Polska S.A.'s senior management as a result of external or internal changes and must be significant to Santander Bank Polska S.A.’s operations and demonstrable to external parties.

2.7. Accounting policies

With the exception of the changes described in point 2.2, the Santander Bank Polska S.A. consistently applied the adopted accounting principles both for the reporting period for which the statement is prepared and for the comparative period.

Foreign currency

Foreign currency transactions

The Polish zloty (PLN) is the functional currency of Santander Bank Polska S.A. Transactions in foreign currencies are translated at the foreign exchange rate ruling at the date of the transaction. Resulting from these transactions monetary assets and liabilities denominated in foreign currencies, are translated at the foreign exchange rate ruling at the balance sheet date. Non-monetary assets and liabilities denominated in foreign currencies, which are stated at historical cost, are translated at the foreign exchange rate ruling at the date of the transaction. Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated to the reporting currency at the foreign exchange rates ruling at the dates that the fair values were determined. Foreign exchange differences arising on translation are recognised in profit or loss except for differences arising on retranslation of equity instruments of other entities measured at fair value through other comprehensive income, which are recognised in other comprehensive income.

Financial assets and liabilities

Recognition and derecognition

Initial recognition

Santander Bank Polska S.A. recognises a financial asset or a financial liability in its statement of financial position when, and only when, it becomes bound by contractual provisions of the instrument.

A regular way purchase or sale of financial assets is recognised and derecognised, as applicable, at the settlement date.

Derecognition of financial assets

Santander Bank Polska S.A. derecognises a financial asset when and only when, if:

·   contractual rights to the cash flows from that financial asset have expired, or

·   Santander Bank Polska S.A. transfers a financial asset, and such operation meets the derecognition criteria specified further in this policy.

Santander Bank Polska S.A. transfers a financial asset when and only when, if:

·   Santander Bank Polska S.A. transfers contractual rights to the cash flows from that financial asset, or

·   Santander Bank Polska S.A. retains contractual rights to receive the cash flows from that financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients in an arrangement that meets the conditions specified further in this policy.

When Santander Bank Polska S.A. retains the contractual rights to receive the cash flows of a financial asset (the ‘original asset’), but assumes a contractual obligation to pay those cash flows to one or more entities (the ‘eventual recipients’), then Santander Bank Polska S.A. treats the transaction as a transfer of a financial asset if, and only if, all of the following three conditions are met:

·   Santander Bank Polska S.A. has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset,

·   Santander Bank Polska S.A. is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows,

·   Santander Bank Polska S.A. has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, Santander Bank Polska S.A. is not entitled to reinvest such cash flows, except for investments in cash or cash equivalents (as defined in IAS 7 Statement of Cash Flows) during the short settlement period from the collection date to the date of required remittance to the eventual recipients, and interest earned on such investments is passed to the eventual recipients.

When Santander Bank Polska S.A. transfers a financial asset, it shall evaluate the extent to which it retains the risks and rewards of ownership of the financial asset. In such a case:  

·   if Santander Bank Polska S.A. transfers substantially all of the risks and rewards of ownership, then it shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer;

·   if Santander Bank Polska S.A. retains substantially all the risks and rewards of ownership, then it shall continue to recognise the financial asset;

·   if Santander Bank Polska S.A. neither transfers nor retains substantially all the risks and rewards of ownership, then it shall verify if it has retained control of the financial asset. In such a case:

a) if Santander Bank Polska S.A. has not retained control, it shall derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer;

b) if Santander Bank Polska S.A. has retained control, it shall continue to recognise the financial asset to the extent of its continuing involvement in the financial asset.

The transfer of risks and rewards is evaluated by comparing Santander Bank Polska S.A.’s exposure, before and after the transfer, with the variability in the amounts and timing of the net cash flows of the transferred asset. Santander Bank Polska S.A. has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer. Santander Bank Polska S.A. transfers substantially all the risks and rewards of ownership of a financial asset if its exposure to such variability is no longer significant in relation to the total variability in the present value of the future net cash flows associated with the financial asset.

Santander Bank Polska S.A. derecognises a part of financial asset (or a part of a group of similar financial assets) when and only when, if the part to be derecognised fulfills one of the three conditions:  

·   that part comprises only specifically identified cash flows on a financial asset (or a group of similar financial assets),

·   that part comprises only a fully proportionate (pro rata) share of cash flows from that financial asset (or a group of similar financial assets),

·   that part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or a group of similar financial assets). 

In all other cases, Santander Bank Polska S.A. derecognises a financial asset (or a group of similar financial assets) as a whole.

Derecognition of financial liabilities

Santander Bank Polska S.A. shall remove a financial liability (or a part of a financial liability) from its statement of financial position when, and only when, it is extinguished — i.e. when the obligation specified in the contract is discharged or cancelled or expires.

An exchange between Santander Bank Polska S.A. and the lender of debt instruments with substantially different terms shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. Similarly, a substantial modification of the terms of an existing financial liability or a part of it (whether or not attributable to the financial difficulty of the debtor) shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.

The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, shall be recognised in profit or loss.

If Santander Bank Polska S.A. repurchases a part of a financial liability, Santander Bank Polska S.A. shall allocate the previous carrying amount of the financial liability between the part that continues to be recognised and the part that is derecognised based on the relative fair values of those parts on the date of the repurchase. The difference between:

·   the carrying amount allocated to the part derecognised, and

·   the consideration paid, including any non-cash assets transferred or liabilities assumed, for the part derecognised, arerecognised in profit or loss.

Classification of financial assets and financial liabilities

Classification of financial assets

Classification of financial assets which are not equity instruments

Unless Santander Bank Polska S.A. has made a prior decision to measure a financial asset at fair value through profit or loss, the Santander Bank Polska S.A. classifies financial asset that are not an equity instrument as subsequently measured at amortised cost or at fair value through other comprehensive income or fair value through profit or loss on the basis of both:

·   the business model of Santander Bank Polska S.A. for managing the financial assets and

·   the contractual cash flow characteristics of the financial asset.

A financial asset is measured at amortised cost if both of the following conditions are fulfilled:

·   the financial asset is held in a business model whose purpose is to hold financial assets to collect contractual cash flows, and

·   the contractual terms of a financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

A financial asset is measured at fair value through other comprehensive income if both of the following conditions are fulfilled:

·   the financial asset is held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets, and

·   the contractual terms of a financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

If a financial asset is not measured at amortised cost or at fair value through other comprehensive income, it is measured at fair value through profit or loss.  

Santander Bank Polska S.A. may, at initial recognition, irrevocably designate a financial asset as measured at fair value through profit or loss if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an “accounting mismatch”) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.

Classification of financial assets which are equity instruments

Santander Bank Polska S.A. measures the financial asset that is an equity instrument at fair value through the profit or loss, unless Santander Bank Polska S.A. made an irrevocable election at initial recognition for particular investments in equity instruments to present subsequent changes in fair value in other comprehensive income.

Santander Bank Polska S.A. classifies investments in other entities that meet criterion of a debt financial instrument as measured at fair value through profit or loss.

Business models

Business models at Santander Bank Polska S.A. are determined at a level that reflects how groups of financial assets are managed together to achieve a particular business objective. The business model does not depend on the intentions of the Santander Bank Polska S.A. key management regarding a particular instrument.

The business model refers to how Santander Bank Polska S.A. manages its financial assets in order to generate cash flows. That is, the business model determines whether cash flows will result from:

·   collecting contractual cash flows

·   selling financial assets

·   or both.

Consequently, the business model assessment is not performed on the basis of scenarios that Santander Bank Polska S.A. does not reasonably expect to occur, such as so-called “worst case” or “stress case” scenarios.

Santander Bank Polska S.A. determines the business model on the basis of the assessment of qualitative and quantitative criteria.

Qualitative criteria for the assessment of a business model

The business model for managing financial assets is a matter of fact and not merely an assertion. It is observable through the activities undertaken to achieve the objective of the business model. Santander Bank Polska S.A. uses judgement when it assesses its business model for managing financial assets and that assessment is not determined by a single factor or activity. Santander Bank Polska S.A. considers all relevant qualitative and quantitative criteria available at the date of business model assessment.  Such relevant evidence includes the following issues: 

·   policies and business objectives applicable to a given portfolio and their effective delivery. In particular, the assessment covers the management strategy for generating income from contractual interest payments, maintaining a specific profile of portfolio interest rates, managing liquidity gap and generating cash flows from the sale of financial assets;

·   method for assessing the profitability of the financial asset portfolio and its reporting and analysis by the key management personnel;

·   risks which affect the profitability and effectiveness of a specific business model (and financial assets held within such a business model) as well as method for managing such risks;

·   method for remunerating business managers as part of a specific business model, i.e. whether the remuneration payable to the key management personnel depends on changes in the fair value of financial assets or the value of contractual cash flows.

Quantitative criteria for the assessment of a business model

In addition to qualitative criteria, the business model should also be reviewed in terms of quantitative aspects, unless the initial analysis of qualitative criteria clearly implies a residual model managed on the fair-value basis.

The purpose of the analysis of quantitative criteria of business model assessment is to determine if the sale of financial assets during the analysed period exceeds the pre-determined threshold values (in percentage terms) defined in internal regulations.

As part of the analysis of quantitative criteria, Santander Bank Polska S.A. reviews the frequency, values and the time of sale of financial assets in the previous reporting periods, reasons for such sale and expectations as to the future sales activity.

In the analysis of the quantitative criteria of the business model assessment, Santander Bank Polska S.A. determines that a business model whose objective is to hold assets in order to collect contractual cash flows enables the sale of those assets, without affecting the current business model, in the following cases:

·   if the sale is due to the increase in credit risk related to the assets,

·   if the sale is infrequent (even if its value is significant),

·   if the value of the sale is insignificant (even if the sale is frequent),

·   if the assets are sold to improve liquidity in a stress case scenario,

·   if the sale is required by third parties (it applies to the assets which have to be sold owing to e.g. the requirements of supervisory authorities, but were originally held to collect contractual cash flows),

·   if the sale results from exceeding the concentration limits specified in internal procedures and is a part of the credit risk management policy,

·   if the sale is made close to the maturity date of the financial assets and the proceeds from the sale are approximations of the contractual cash flows that Santander Bank Polska S.A. would have collected if it had held the assets until their maturity date.

Other forms of the sale of assets as part of the business model whose objective is to hold assets in order to collect contractual cash flows (e.g. frequent sales of significant value) result in the need to change the business model and reclassify the financial assets which were originally allocated to that model.

Business model types

The analysis of qualitative and quantitative criteria makes it possible to identify three basic business models applied in the operations of Santander Bank Polska S.A.:

·   the business model whose objective is to hold assets in order to collect contractual cash flows (hold to collect),

·   the business model whose objective is achieved by both collecting contractual cash flows and selling financial assets (hold to collect and sell),

·   the other/ residual business model (the business model whose objective is achieved by selling assets).

Presented below are characteristics of all business models, with an indication of the financial instruments assigned to each.

A business model whose objective is to hold assets in order to collect contractual cash flows

Financial assets that are held within a business model whose objective is to hold assets in order to collect contractual cash flows are managed to realise cash flows by collecting contractual payments over the whole life of the instrument. That is, Santander Bank Polska S.A. manages the assets held within the portfolio to collect those particular contractual cash flows (instead of managing the overall return on the portfolio by both holding and selling assets). In determining whether cash flows are going to be realised by collecting the financial assets' contractual cash flows, it is necessary to consider the frequency, value and timing of sales in prior periods, the reasons for those sales and expectations about future sales activity. However, sales in themselves do not determine the business model and therefore cannot be considered in isolation. Instead, information about past sales and expectations about future sales provide evidence related to how Santander Bank Polska S.A.’s stated objective for managing the financial assets is achieved and, specifically, how cash flows are realised. Santander Bank Polska S.A. each time considers information about past sales within the context of the reasons for those sales and the conditions that existed at that time as compared to current conditions. Although the objective of the business model may be to hold financial assets in order to collect contractual cash flows, Santander Bank Polska S.A. needs not hold all of those instruments until maturity. Thus, Santander Bank Polska S.A.’s business model can be to hold financial assets to collect contractual cash flows even when sales of financial assets occur or are expected to occur in the future.

A business model whose objective is to hold assets in order to collect contractual cash flows spans the entire spectrum of credit activity, including but not limited to corporate loans, mortgage and consumer loans, credit cards, loans granted and debt instruments (e.g. treasury bonds, corporate bonds), which are not held for liquidity management purposes. Financial assets on account of trading settlements are substantially also recognised under this model. Such assets are recognised in the books of Santander Bank Polska S.A. on the basis of an invoice issued payable within maximum one year.

A business model whose objective is achieved by both collecting contractual cash flows and selling financial assets

Santander Bank Polska S.A. may hold financial assets in a business model whose objective is achieved both by collecting contractual cash flows and by selling financial assets. In this type of business model, the key management personnel of Santander Bank Polska S.A. decided that both collecting contractual cash flows and selling financial assets are integral to

achieving  the business model’s objective. There are various objectives that may be consistent with this type of business model. For example, the objective of the business model may be to manage everyday liquidity needs, to maintain a particular interest yield profile or to match the duration of the financial assets to the duration of the liabilities that those assets are funding. To achieve such an objective, Santander Bank Polska S.A. will both collect contractual cash flows and sell financial assets.

Compared to a business model whose objective is to hold financial assets to collect contractual cash flows, this business model will typically involve greater frequency and value of sales. This is because selling financial assets is integral to achieving the business model's objective instead of being only incidental to it. However, there is no specific frequency or sales value threshold that must be achieved in this business model as collecting contractual cash flows and selling financial assets are both integral to achieving the model's objective.

A business model whose objective is achieved by both collecting contractual cash flows and selling financial assets includes:

·   financial assets acquired for the purpose of liquidity management, such as State Treasury bonds or NBP bond and

·   loans and advances subject to underwriting, i.e. portion of credit exposures that are planned to be sold before maturity for reasons other than increase in credit risk.

Other/ residual business model

Financial assets are measured at fair value through profit or loss if they are not held within a business model whose objective is to hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. A business model that results in measurement at fair value through profit or loss is one in which Santander Bank Polska S.A. manages the financial assets with the objective of realising cash flows through the sale of the assets. Santander Bank Polska S.A. makes decisions based on the assets' fair values and manages the assets to realise those fair values. In this case, Santander Bank Polska S.A.’s objective will typically result in active buying and selling. Even though Santander Bank Polska S.A. will collect contractual cash flows while it holds the financial assets, the objective of such a business model is not achieved by both collecting contractual cash flows and selling financial assets. This is because the collection of contractual cash flows is not integral to achieving the business model's objective; instead, it is incidental to it.

Other, residual model is used for classifying assets held by Santander Bank Polska S.A. but not covered by the first or second category of the business model. They include assets from the “held for trading” category in the financial statements, such as listed equity instruments, commercial bonds acquired for trading purposes and derivatives (e.g. options, IRS, FRA, CIRS, FX Swap contracts) which are not embedded derivatives.

The business model whose objective is to hold assets in order to collect contractual cash flows is the most frequent business model in Santander Bank Polska S.A. except in the case of:

·   debt instruments measured at fair value through other comprehensive income that are maintained in the ALM segment and credits and loans covered by underwriting process described above; those instruments are subject to the business model whose objective is achieved by both collecting contractual cash flows and selling financial assets,

·   instruments held for trading, including debt instruments and derivative instruments which are not subject to hedge accounting; those instruments are covered by the other/ residual business model.

Changing the business model

Santander Bank Polska S.A. reclassifies all affected financial assets when, and only when, it changes its business model for managing financial assets. Such changes are expected to be very infrequent. They are determined by the senior management of Santander Bank Polska S.A. as a result of external or internal changes and must be significant to the Santander Bank Polska ‘s S.A.   operations and demonstrable to external parties. Accordingly, a change in the business model of Santander Bank Polska S.A. will occur only when Santander Bank Polska S.A. either begins or ceases to perform an activity that is significant to its operations (for example, when a business line has been acquired, disposed of or terminated).

The objective of the business model of Santander Bank Polska S.A. is changed before the reclassification date.

The following are not changes in business model:

·   a change in intention related to particular financial assets (even in circumstances of significant changes in market conditions),

·   the temporary disappearance of a particular market for financial assets,

·   a transfer of financial assets between segments of Santander Bank Polska S.A. with different business models.

If Santander Bank Polska S.A. reclassifies a financial asset, it applies the reclassification prospectively from the reclassification date.

If Santander Bank Polska S.A. reclassifies a financial asset out of the amortised cost measurement category and into the fair value through profit or loss measurement category, its fair value is established at the reclassification date.

Any gain or loss arising from a difference between the previous amortised cost of the financial asset and fair value is recognised in profit or loss.

Characteristics of contractual cash flows

Santander Bank Polska S.A. classifies financial assets on the basis of the contractual cash flow characteristics of the financial asset if that asset is held within a business model:

·   whose objective is to hold assets to collect contractual cash flows or

·   whose objective is achieved by both collecting contractual cash flows and selling financial assets unless Santander Bank Polska S.A. has designated that financial asset to be measured at fair value through profit or loss.

For this purpose, Santander Bank Polska S.A. determines if the contractual cash flows generated by the asset in question are solely payments of principal and interest on the principal amount outstanding.

Principal is the fair value of the financial asset at initial recognition. However, that principal amount may change over the life of the financial asset (for example, if there are repayments of principal).

Interest should include the consideration for:

·   the time value of money,

·   credit risk associated with the outstanding principal amount,

·   other basic lending risks and costs,

·   and a profit margin.

The time value of money is the element of interest that provides consideration for only the passage of time. That is, the time value of money element does not provide consideration for other risks or costs associated with holding the financial asset. In order to assess whether the element provides consideration for only the passage of time, Santander Bank Polska S.A. applies its own judgement and considers relevant factors such as the currency in which the financial asset is denominated and the period for which the interest rate is set.

Credit risk is defined as the risk that one party to a financial instrument will cause a financial loss for Santander Bank Polska S.A. by failing to discharge an obligation. In other words, credit risk refers to the possibility of the Customer’s failure to repay the principal and interest due within the contractual deadline.

Other basic lending risks and costs include for example administration costs related to the analysis of the credit application, assessment of the customer’s repayment capacity, monitoring of the customer’s economic and financial standing, etc.

Financial instruments which do not meet the requirements of contractual cash flow characteristics and are valued with fair value through profit and loss, include:

·   credit card portfolios whose interest rates are set on the basis of principles applicable in Santander Bank Polska S.A. until 1 August 2016;

·   instruments providing for participation of Santander Bank Polska S.A. in the customer’s profit or loss; and

·   other instruments whose contractual cash flows do not meet the definition of interest due to the lack of an economic relationship between the amount of interest accrued and the amount of interest payable to Santander Bank Polska S.A.

Classification of financial liabilities

Santander Bank Polska S.A. classifies all financial liabilities as subsequently measured at amortised cost, except for:

·       financial liabilities measured at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair value.

·       financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies;

·       financial guarantee contracts. After initial recognition, the issuer shall measure contract at the higher of:

(1)    amount of the expected credit loss allowance,

(2)    initial recognised amount, less respective cumulated income recognised as per IFRS 15;

·       commitments to provide a loan at a below-market interest rate. If the liability is not measured at fair value through profit or loss, the issuer shall subsequently measure it at the higher of:

(3)    amount of the expected credit loss allowance,

(4)    Initial recognised amount, less respective cumulated income recognised as per IFRS 15;

·       contingent consideration recognised by the acquire under the business combination arrangement governed by IFRS 3. Such contingent consideration shall subsequently be measured at fair value with changes recognised in profit or loss.

Upon initial recognition of the liability, Santander Bank Polska S.A. may irrevocably classify such item as the one measured at fair value through profit or loss if such an accounting method provides a better view of the accounts, because:

·       it eliminates or largely prevents the accounting mismatch that would arise if assets or liabilities or related profit or loss were recognised under different accounting methods, or

·       a group of financial liabilities or  financial assets and liabilities is managed and measured at fair value as per the documented strategy for risk management and investments, and information about these items are provided to key management personnel  within the Santander Bank Polska S.A. (as per the definition specified in IAS 24 Related Party Disclosures).

Embedded derivatives

An embedded derivative is a component of a hybrid contract that also includes a non-derivative host—with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable independently of that instrument, or has a different counterparty, is not an embedded derivative, but a separate financial instrument.

For financial assets, that meet the definition of hybrid contracts with an embedded derivative, a derivative that is a component of such a contract is not separated from the host contract which is not a derivative, the entire contract is assessed in terms of the contractual cash flow characteristics.

Measurement of financial assets and financial liabilities

Initial measurement

At initial recognition, Santander Bank Polska S.A. measures a financial asset or financial liability at its fair value plus or minus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability.

However, if the fair value of the financial asset or financial liability at initial recognition differs from the transaction price, Santander Bank Polska S.A. recognises this instrument on that date as follows:

·   when the fair value is evidenced by a quoted price in an active market for an identical asset or liability (i.e. a Level 1 input) or based on a valuation technique that uses only data from observable markets, then Santander Bank Polska S.A. recognises the difference between the transaction price and the fair value at initial recognition as a gain or loss.

·   in all other cases, at the measurement adjusted to defer the difference between the fair value at initial recognition and the transaction price. After initial recognition, Santander Bank Polska S.A. recognises that deferred difference as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing the asset or liability.

At initial recognition, Santander Bank Polska S.A. shall measure trade receivables that do not have a significant financing component (determined in accordance with IFRS 15) at their transaction price (as defined in IFRS 15).

Subsequent measurement of financial assets

After initial recognition, Santander Bank Polska S.A. recognises a financial asset:

·   at amortised cost, or

·   at fair value through other comprehensive income, or

·   at fair value through profit or loss.

Allowances for expected credit losses  are not calculated for financial assets measured at fair value through profit or loss.

Subsequent measurement of financial liabilities

After initial recognition, Santander Bank Polska S.A. recognises a financial liability:

·   at amortised cost, or

·   at fair value through profit or loss.

Liabilities measured at amortised costs include: deposits from banks, deposits from customers, liabilities due to repo transactions, loans and advances obtained, issued debt instruments and subordinated liabilities.

Liabilities are recognised as subordinated liabilities which in the event of liquidation or bankruptcy of Santander Bank Polska S.A. are repaid after satisfaction of claims of all other Santander Bank Polska S.A. creditors. Financial liabilities are classified as subordinated liabilities by the decision of the Polish Financial Supervision Authority issued at the request of Santander Bank Polska S.A.

Amortised cost measurement

Financial assets

Effective interest method

Interest revenue is calculated by applying the effective interest rate to the gross carrying amount of financial assets, except for credit-impaired financial assets. At the time a financial asset or a group of similar financial assets is reclassified to stage 3, interest revenue is calculated on the basis of a net value of a financial asset and presented at the interest rate used for the purpose of discounting the future cash flows for the purpose of measurement of impairment.

In case of interest revenue on POCI assets is calculated on the basis of the net carrying amount, applying the effective interest rate adjusted for credit risk over the lifetime of the asset. The credit-adjusted effective interest rate is calculated by taking into account the future cash flows adjusted for the effect of credit risk over the lifetime of the asset.

The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, Santander Bank Polska S.A. shall estimate cash flows considering all contractual terms of the financial instrument (for example, prepayment, call and similar options) but does not consider potential future credit losses.

The calculation includes paid and received fees (e.g. arrangement and grant of loan, arrangement of loan tranche, prolongation of loan, renewal of loan, restructure fees and fees for annexes which modify payments) transaction costs and all other premiums or discounts.

Costs that can be directly related to the sales of loan products are partially accounted for in interest income using the effective interest method, if there is a possibility of direct allocation to the specific loan agreement, and partly recognised in the fee income, at the moment of realisation, if there is no possibility of direct allocation to the specific loan agreement.

Credit-adjusted effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial asset to the amortised cost of a financial asset that is a purchased or originated credit-impaired financial asset. When calculating the credit-adjusted effective interest rate, Santander Bank Polska S.A. estimates the expected cash flows by considering all contractual terms of the financial asset (for example, prepayment, extension, call and similar options) and expected credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other

premiums or discounts. There is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare cases when it is not possible to reliably estimate the cash flows or the remaining life of a financial instrument (or group of financial instruments), Santander Bank Polska S.A. uses the contractual cash flows over the full contractual term of the financial instrument (or group of financial instruments).

The gross carrying amount of a financial asset is its amortised cost, before adjusting for any expected credit loss allowances, and taking into account any non-derecognised penalty interest accrued on overdue principal.

Purchased or originated credit-impaired assets  (POCI)

Santander Bank Polska S.A.  distinguished the category of purchased or originated credit-risk assets . POCI are assets that are credit-impaired on initial recognition. Financial asset that were classified as POCI at initial recognition should be treated as POCI in all subsequent periods until they are derecognized.

At initial recognition, POCI assets are recognized at their fair value. After initial recognition POCI assets are measured  at amortized costs.

Valuation of POCI assets is based on the effective interest rate  adjusted for the effect of credit risk .

For POCI assets (purchased or originated credit impaired) expected credit losses are recognised over the lifetime of the asset.

Modification of contractual cash flows

The concept of modification

Changes to the contractual cash flows in respect of the financial asset are regarded by Santander Bank Polska S.A. as modification if made in the form of an annex. Changes to the contractual cash flows arising from performance of the contractual obligations are not considered to be a modification.

If the terms of the financial asset agreement change, the Santander Bank Polska S.A. assesses whether the cash flows generated by the modified asset differ significantly from cash flows generated by financial asset before modification of the terms of the asset agreement.

Modification criteria

When assessing whether a modification is substantial or minor, Santander Bank Polska S.A. takes into account both quantitative and qualitative criteria. Both criteria groups are each time analyzed together.

COVID-19 debt moratorium itself is not a trigger for significant modification and financial instrument derecognition. Deferral or suspension of installments repayments under assistance programs were evaluated according to existing in Bank qualitative and quantitative criteria.

Quantitative criteria

To determine the significance of the impact of modifications, the so-called "10% test" is carried out which is based on a comparison of discounted cash flows of the modified financial instrument (using the original effective interest rate) with discounted (also with the original effective interest rate) cash flows of the financial instrument before modification, whose value should correspond to the value of undue capital, increased by the value of undue interest and adjusted for the amount of unsettled commission.

Qualitative criteria

During the qualitative analysis, Santander Bank Polska S.A. takes into account the following aspects:

·   adding / removing a feature that violates the contractual cash flow test result,

·   currency conversion - except for currency conversions resulting from the transfer of the contract for collection,

·   change of the main debtor - change of the contractor results in a significant modification of contractual terms and

·   consolidation of several exposures into one under an annex.

Substantial modification

Identification of substantial modification resulting in the exclusion of a financial instrument from the statement of financial position is based on qualitative and quantitative criteria described above.

In addition, a substantial modification occurs when the cash flows of the modified financial instrument are "materially different" from the original financial instrument, i.e. when the difference between discounted cash flows of the modified financial instrument (using the original effective interest rate) and the discounted (also with the original effective interest rate), cash flows of the financial instrument before the modification, is higher than 10%.

If the modification of a financial asset results in derecognition of the existing financial asset and recognition of the modified financial asset, the modified asset is considered as a "new" financial asset. The new asset is recognized at fair value and the new effective interest rate applied to the new asset is calculated.

Minor modification

If neither the qualitative criteria, nor the quantitative ones are met, the modification is regarded by Santander Bank Polska S.A. as insignificant.

When the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in the derecognition of that financial asset in accordance with this policy, Santander Bank Polska S.A. recalculates the gross carrying amount of the financial asset and shall recognise a modification gain or loss in profit or loss. The gross carrying amount of the financial asset shall be recalculated as the present value of the renegotiated or modified contractual cash flows that are discounted at the financial asset's original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets) or, when applicable, the revised effective interest rate. Any costs or fees incurred adjust the carrying amount of the modified financial asset and are amortised over the remaining term of the modified financial asset. Change in gross carrying amount is amortised into interest income/cost using effective interest rate method.

Write-off

Santander Bank Polska S.A. directly reduces the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write-off constitutes a derecognition event.

Financial asset can be written off partially or in its entirety.

Santander Bank Polska S.A. writes off financial assets if at least one of the following conditions apply:

·   Santander Bank Polska S.A. has documented the irrecoverability of the debt

·   there are no reasonable expectations of recovering the financial asset in full or in part;

·   the debt is due and payable in its entirety and the value of the credit loss allowance corresponds to the gross value of the exposure, while the expected debt recovery proceeds are nil; 

·   the asset originated as a result of a crime and the perpetrators have not been identified or

·   Santander Bank Polska S.A. has received:

·     a decision on discontinuation of debt enforcement proceedings due to irrecoverability of the debt (in relation to all obligors), issued by a relevant enforcement authority pursuant to Article 824 § 1 (3) of the Polish Code of Civil Procedure, which is recognised by the Santander Bank Polska S.A. as corresponding to the facts;

·     a court decision in respect of :

-      dismissing a bankruptcy petition, if the insolvent debtor's assets are insufficient to cover the cost of the proceedings or suffice to cover this cost only; or

-      discontinuing the bankruptcy proceedings or

-      closing the bankruptcy proceedings.

Financial assets written off are then recorded off balance sheet. Analogous premises are taken into account in the case of writing off penalty interest.

Impairment

General approach

Santander Bank Polska S.A. recognises allowances for expected credit losses on a financial asset in respect of:

·   financial assets measured at amortised cost or at fair value through other comprehensive income;

·   lease receivables;

·   contract assets, i.e. the consideration to which Santander Bank Polska S.A. is entitled in exchange for the goods or services transferred to the customer in accordance with IFRS 15 Revenue from Contracts with Customers;

·   loan commitments and

·   off-balance sheet credit liabilities and financial guarantees.

Santander Bank Polska S.A. applies the impairment requirements for the recognition and measurement of a loss allowance for financial assets that are measured at fair value through other comprehensive income. However, the loss allowance is recognised in income statement and does not reduce the carrying amount of the financial asset in the statement of financial position.

At each reporting date, Santander Bank Polska S.A. measures the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition.

The objective of the impairment requirements is to recognise lifetime expected credit losses for all financial instruments for which there have been significant increases in credit risk since initial recognition — whether assessed on an individual or collective basis — considering all reasonable and supportable information, including that which is forward-looking.

If, at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, Santander Bank Polska S.A. measures the loss allowance for that financial instrument at an amount equal to 12-month expected credit losses.

For loan commitments and financial guarantee contracts, the date that Santander Bank Polska S.A. becomes a party to the irrevocable commitment shall be considered to be the date of initial recognition for the purposes of applying the impairment requirements.

If Santander Bank Polska S.A. has measured the loss allowance for a financial instrument at an amount equal to lifetime expected credit losses in the previous reporting period, but determined at the current reporting date that the credit risk for that financial instrument has declined, Santander Bank Polska S.A. measures the loss allowance at an amount equal to 12-month expected credit losses at the current reporting date.

Santander Bank Polska S.A. recognises in profit or loss, as an impairment gain or loss, the amount of expected credit losses that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognised.

Santander Bank Polska S.A. charges interest revenue on exposures classified in Stage 3 on the net exposure value.

Simplified approach for trade receivables and contract assets

In the case of trade receivables and contract assets, Santander Bank Polska S.A. always measures the loss allowance at an amount equal to lifetime expected credit losses for trade receivables or contract assets that result from transactions that are within the scope of IFRS 15, and that do not contain a significant financing component.

Purchased or originated credit-impaired financial assets (POCI assets)

At the reporting date, Santander Bank Polska S.A. recognises only the changes in lifetime expected credit losses as a loss allowance for purchased or originated credit-impaired financial assets.

Interest revenue on POCI assets is calculated on the basis of the net carrying amount, applying the effective interest rate adjusted for credit risk over the lifetime of the asset. The credit-adjusted effective interest rate is calculated by taking into account the future cash flows adjusted for the effect of credit risk over the lifetime of the asset.

At each reporting date, Santander Bank Polska S.A. recognises in profit or loss the amount of the change in lifetime expected credit losses as an impairment gain or loss. Santander Bank Polska S.A. recognises favourable changes in lifetime expected credit losses as an impairment gain, even if the lifetime expected credit losses are less than the amount of expected credit losses that were included in the estimated cash flows on initial recognition.

Contingent liabilities

Santander Bank Polska S.A. creates provisions for impairment risk-bearing irrevocable contingent liabilities (irrevocable credit lines, financial guarantees, letters of credit, etc.). The value of the provision is determined as the difference between the estimated amount of available contingent exposure set using the Credit Conversion Factor (CCF) and the current value of expected future cash flows under this exposure.

Santander Bank Polska S.A. raises provisions for off-balance sheet liabilities subject to credit risk, broken down into 3 stages.

Gains and losses

A gain or loss on a financial asset or liability measured at fair value is recognised in profit or loss unless the asset or liability is:

·   a part of a hedging relationship,

·   an investment into an equity instrument and Santander Bank Polska S.A. has decided to present gains and losses on that investment in other comprehensive income,

·   a financial liability designated as measured at fair value through profit or loss and Santander Bank Polska S.A. is required to present the effects of changes in the liability's credit risk in other comprehensive income; or

·   is a financial asset measured at fair value through other comprehensive income and Santander Bank Polska S.A. is required to recognise some changes in fair value in other comprehensive income.

Dividends are recognised in profit or loss only if:

·   the right of Santander Bank Polska S.A. to receive payment of the dividend is established,

·   it is probable that the economic benefits associated with the dividend will flow to Santander Bank Polska S.A., and

·   the amount of the dividend can be measured reliably.

A gain or loss on a financial asset that is measured at amortised cost and is not part of a hedging relationship is recognised in profit or loss through the amortisation process or in order to recognise impairment gains or losses. A gain or loss on a financial liability that is measured at amortised cost and is not part of a hedging relationship is recognised in profit or loss when the financial liability is derecognised and through the amortisation process.  

With regard to the financial assets recognised by Santander Bank Polska S.A. at the settlement date, any change in the fair value of the asset to be received during the period between the trade date and the settlement date is not recognised for assets measured at amortised cost. For assets measured at fair value, however, the change in fair value is recognised in profit or loss or in other comprehensive income, as appropriate. The trade date means the date of initial recognition for the purposes of applying the impairment requirements.

Investments in equity instruments

Investments in equity instruments are measured at fair value through profit or loss unless at their initial recognition Santander Bank Polska S.A. makes an irrevocable election to present in other comprehensive income subsequent changes in the fair value of an investment in an equity instrument within the scope of this policy that is neither held for trading nor contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies.

If Santander Bank Polska S.A. has elected to measure equity instruments at fair value through other comprehensive income, dividends from that investment are recognised in profit or loss.

Liabilities designated as measured at fair value through profit or loss

Santander Bank Polska S.A. presents a gain or loss on a financial liability that is designated as measured at fair value through profit or loss as follows:

·   the amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability is presented in other comprehensive income, and

·   the remaining amount of change in the fair value of the liability is presented in profit or loss unless the treatment of the effects of changes in the liability's credit risk described in (a) would create or enlarge an accounting mismatch in the profit or loss of Santander Bank Polska S.A..

If the requirements specified above would create or enlarge an accounting mismatch in the profit or loss of Santander Bank Polska S.A., Santander Bank Polska S.A. presents all gains or losses on that liability (including the effects of changes in the credit risk of that liability) in profit or loss.

Santander Bank Polska S.A. presents in profit or loss all gains and losses on loan commitments and financial guarantee contracts that are designated as measured at fair value through profit or loss.

Assets measured at fair value through other comprehensive income

A gain or loss on a financial asset measured at fair value through other comprehensive income is recognised in other comprehensive income, except for impairment gains or losses and foreign exchange gains and losses, until the financial asset is derecognised .If the financial asset is derecognised , Santander Bank Polska S.A. accounts for the cumulative gain or loss that was previously recognised in other comprehensive income in profit or loss. Interest calculated using the effective interest method is recognised in profit or loss.

Financial instruments held for trading

A financial asset or financial liability is classified by Santander Bank Polska S.A. as held for trading if:  

·   it has been acquired or incurred principally for the purpose of selling or repurchasing in the near term,

·   on initial recognition it is a part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking; or

·   it is a derivative (except for a derivative that is a financial guarantee contract or a designated and effective hedging instrument).

Derivative financial instruments are recognised at fair value without any deduction for transactions costs to be incurred on sale. The best evidence of the fair value of a financial instrument at initial recognition is the transaction price (i.e. the fair value of the consideration given or received).

If a hybrid contract contains a host contract that is not an asset within the scope of this IFRS 9, Santander Bank Polska S.A. separates the embedded derivative from the host contract and accounts for it as other derivatives if the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract and the host contract is not carried at fair value through profit or loss. Embedded derivatives are measured at fair value with changes recognised in the profit and loss account.

Santander Bank Polska S.A. uses derivative financial instruments to hedge its exposure to FX risk and interest rate risk arising from Santander Bank Polska S.A.’s operations. The derivatives that do not qualify for hedge accounting are accounted for as instruments held for trading and recognised at fair value.

Hedge accounting

Pursuant to paragraph 7.2.21 of IFRS 9, Santander Bank Polska S.A. chose to continue to apply the hedge accounting requirements and hedging relationships arising from IAS 39.

Hedge accounting recognises the offsetting effects on the income statement income of changes in the fair values of the hedging instrument and the hedged item.At the inception of the hedge there is formal designation and documentation of the hedging relationship and risk management objective and strategy for undertaking the hedge. The documentation includes identification of the hedging instrument, the hedged item or transaction and the nature of the risk being hedged. The Santander Bank Polska S.A. also documents, at inception and on ongoing basis, an assessment of the hedging instrument's effectiveness in offsetting the exposure to changes in the fair value of the hedged item.

The Santander Bank Polska S.A. uses derivative financial instruments among others to hedge its exposure to interest rate risks arising from Santander Bank Polska S.A. operational, financing and investment activities.

The Santander Bank Polska S.A. discontinues hedge accounting when:

·       it is determined that a derivative is not, or has ceased to be, effective as a hedge;

·       the derivative expires, or is sold, terminated, or exercised;

·       the hedged item matures or is sold, or repaid,

·       the hedging relationship ceases.

Fair value hedge

This is a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect the income statement.

A fair value hedge is accounted for as follows: the gain or loss from remeasuring the hedging instrument at fair value (for a derivative hedging instrument) shall be recognised in profit or loss; and the gain or loss on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognised in profit or loss. This rule applies if the hedged item is otherwise measured at amortised cost or is a financial asset measured at fair value through other comprehensive income.

Cash flow hedge

This is a hedge of the exposure to variability in cash flows that:

1.      is attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction; and

2.      could affect profit and losses.

A cash flow hedge is accounted for as follows: the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised directly in other comprehensive income and the ineffective portion of the gain or loss on the hedging instrument shall be recognised in income statement.

Interest income and expenses on hedged and hedging instruments are recognised as net interest income.

Amounts recognised in ‘Other comprehensive income’ are reclassified to profit or loss during the period of time in which the hedged item affects the income statement.

If the hedging instrument expires or is sold or the hedge accounting relationship is terminated, Santander Bank Polska S.A. discontinues hedge accounting. All profits or losses on the hedging instrument pertaining to the effective hedge recognised in other comprehensive income remains an element of equity until the forecast transaction occurs, when it is recognised in income statement.

If the transaction is no longer expected to occur, the cumulative gain or loss relating to the hedging instrument recognised in other comprehensive income is reclassified to profit or loss.

Repurchase and reverse repurchase transactions

The Santander Bank Polska S.A. also generates/invests funds by selling/purchasing financial instruments under repurchase/reverse repurchase agreements whereby the instruments must be repurchased/resold at the previously agreed price.

Securities sold subject to repurchase agreements (“repo and sell-buy-back transaction”) are not derecognised from the statement of financial position at the end of the reporting period. The difference between sale and repurchase price is treated as interest cost and accrued over the life of the agreement.

Securities purchased subject to resale agreements (“reverse repo and buy-sell-back transactions”) are not recognised in the statement of financial position at the end of the reporting period. The difference between purchase and resale price is treated as interest income and accrued over the life of the agreement.

The principles described above are also applied by Santander Bank Polska  S.A. to transaction concluded as separate transaction of sale and repurchase of financial instruments but having the economic nature of repurchased and reverse repurchase transactions.

Property, plant and equipment

Owned fixed assets

Property, plant and equipment including assets under operating leases are stated at cost or deemed cost less accumulated depreciation and impairment losses.

Leased assets

Cost model

Santander Bank Polska S.A as a lessee shall measure the right-of-use asset at cost:

a)     less any accumulated depreciation and any accumulated impairment losses; and

b)     adjusted for any remeasurement of the lease liability

Subsequent expenditure

Santander Bank Polska S.A. recognises in the carrying amount of property, plant and equipment the cost of replacing part of such an asset when that cost is incurred if it is probable that the future economic benefits embodied with the item will flow to Santander Bank Polska S.A. and the cost of the item can be measured reliably. All other costs are recognised in the income statement as an expense as incurred.

Depreciation

Depreciation is charged to the income statement on a straight-line basis over the estimated economic useful lives of each part of an item of property, plant and equipment.

The estimated economic useful lives are as follows:

·   buildings: 22-40 years

·   IT equipment: 3 years

·   transportation means: 4 years

·   other fixed assets: 14 years.

Right-of-use assets are depreciated on a straight basis overt the assets’s useful life.

Depreciation rates are verified annually. On the basis of this verification, depreciation periods might be changed.

Goodwill and Intangible assets

Goodwill

Goodwill as of the acquisition date measured as the excess of the consideration transferred over the net of the acquisition-date amounts of the identifiable acquired assets, liabilities and contingent liabilities less impairment. Goodwill value is tested for impairment annually.

Licences, patents, concession and similar assets

Acquired computer software licences are recognized on the basis of the costs incurred to acquire and bring to use the specific software.

Expenditures that are directly associated with the production of identifiable and unique software products controlled by Santander Bank Polska S.A., and that will probably generate economic benefits exceeding expenditures beyond one year, are recognised as intangible assets.

Development costs

Santander Bank Polska S.A. capitalises direct costs and a justified part of indirect costs related to the design, construction and testing of a chosen alternative for new or improved processes, systems or services.

Santander Bank Polska S.A. recognises the development costs as intangible assets based on the future economic benefits and fulfilment of conditions specified in IAS 38, i.e.:

·   has the ability and intention to complete and use the asset that is being generated,

·   has the adequate technical and financial measures to complete the works and use the asset that is being generated and

·   can reliably measure the amount of expenditure incurred during the development works that can be allocated to the generated intangible asset.

The economic life of development costs is definite. The amortisation rates are adjusted to the length of the economic life. Santander Bank Polska S.A. indicates separately the costs from internal development. Development expenditure comprises all expenditure that is directly attributable to development activities.

Other intangible assets

Other intangible assets that are acquired by Santander Bank Polska S.A. are stated at cost less accumulated amortisation and total impairment losses.

Expenditure on intangible assets

Subsequent expenditure on capitalised intangible assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed in the income statement as incurred.

Amortisation

Amortisation is charged to the income statement on a straight-line or degressive method (for intangible assets resulting from business combinations) over the estimated economic useful lives of intangible assets, which for the majority of intangibles equals to three years.

Amortisation rates are verified annually. On the basis of this verification, amortisation periods might be changed.

Leasing

Separating elements of the leasing contract

Lessee

Santander Bank Polska  (the lessee) does not separate non-lease components from lease components, and instead accounts for each lease component and any associated non-lease components as a single lease component for each underlying asset class where it is not possible and where the share of non-lease components is not significant compared to total net lease payments.

Lessor

For a contract that contains a lease component and one or more additional lease or non-lease components, Santander Bank Polska  (the lessor) allocates the consideration in the contract applying the provisions of the accounting policy in respect of revenue from contracts with customers.

Lease term

Santander Bank Polska  determines the lease term as the non-cancellable period of a lease, together with both:

·   periods covered by an option to extend the lease if Santander Bank Polska S.A. (the lessee) is reasonably certain to exercise that option; and

·   periods covered by an option to terminate the lease if Santander Bank Polska S.A. (the lessee) is reasonably certain not to exercise that option.

The lease term is updated upon the occurrence of either a significant event or a significant change in circumstances.

Santander Bank Polska S.A. as the lessee

Recognition

At the commencement date, Santander Bank Polska S.A. (the lessee) recognises a right-of-use asset and a lease liability.

Initial measurement

Initial measurement of the right-of-use asset

At the commencement date, Santander Bank Polska S.A. (the lessee) measures the right-of-use asset at cost.

The cost of the right-of-use asset comprises:

·   the amount of the initial measurement of the lease liability;

·   any lease payments made at or before the commencement date, less any lease incentives received;

·   any initial direct costs incurred by Santander Bank Polska S.A. (the lessee); and

·   an estimate of costs to be incurred by Santander Bank Polska S.A. (the lessee) in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease.

Initial measurement of the lease liability

At the commencement date, Santander Bank Polska S.A. (the lessee) measures the lease liability at the present value of the lease payments that are not paid at that date. The lease payments are discounted using the interest rate implicit in the lease, if that rate can be readily determined. Otherwise, Santander Bank Polska S.A.(the lesse) uses its incremental borrowing rate.

At the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date:

·   net fixed lease  payments (including in-substance fixed lease payments), less any lease incentives;

·   net variable lease payments that depend on an index or a rate;

·   net amounts expected to be payable by the lessee under residual value guarantees;

·   net exercise price of a call option if the lessee is reasonably certain to exercise that option; and

·   payments of net penalties for terminating the lease, if the lease term reflects that Santander Bank Polska S.A. (the lessee) may exercise an option to terminate the lease.

Lease modifications

Santander Bank Polska S.A. (the lessee) accounts for a lease modification as a separate lease if both:

·   the modification increases the scope of the lease by adding the right to use one or more underlying assets; and

·   the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope and any appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.

For a lease modification that is not accounted for as a separate lease, at the effective date of the lease modification Santander Bank Polska S.A. (the lessee):

·   does not allocate the consideration in the modified contract;

·   determines the lease term of the modified lease; and

·   remeasures the lease liability by discounting the revised lease payments using a revised discount rate.

Recognition exemptions

Santander Bank Polska S.A. (the lessee) does not apply the recognition and measurement requirements arising from the accounting policy to:

·   leases which start date period of no longer than 12 months

·   leases for which the underlying asset is of low value (i.e. if the net value of a new asset is lower or equal to PLN 20,000).

In the case of short-term leases or leases for which the underlying asset is of low value, Santander Bank Polska S.A. ( the lessee) recognises the lease payments associated with those leases as an expense on  a straight-line basis over the lease term.

Santander Bank Polska S.A. as the lessor

Classification of leases

Santander Bank Polska S.A. (the lessor) classifies each of its leases as either an operating lease or a finance lease.

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

Lease classification is made at the inception date and is reassessed only if there is a lease modification.

Finance lease

Recognition and measurement

At the commencement date, Santander Bank Polska S.A. (the lessor) recognises assets held under a finance lease in its statement of financial position and presents them as a receivable at an amount equal to the net investment in the lease.

Initial measurement

Santander Bank Polska S.A. (the lessor) uses the interest rate implicit in the lease to measure the net investment in the lease.

Initial direct costs are included in the initial measurement of the net investment in the lease and reduce the amount of income recognised over the lease term.

Initial measurement of the lease payments included in the net investment in the lease.

At the commencement date, the lease payments included in the measurement of the net investment in the lease comprise the following payments for the right to use the underlying asset during the lease term that are not received at the commencement date:

·   net fixed lease payments less any lease incentives payable;

·   net variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date;

·   any net residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee;

·   net exercise price of a call option if the lessee is reasonably certain to exercise that option; and

·   payments of penalties for terminating the lease, if the lease term reflects that the lessee may exercise an option to terminate the lease.

Subsequent measurement

Finance income is recognised over the lease term based on a pattern reflecting a constant periodic rate of return on the lessor's net investment in the lease.

Santander Bank Polska S.A. (the lessor) allocates finance income over the lease term on a systematic and rational basis. The lease payments relating to the period reduce the net investment in the lease Santander Bank Polska S.A. (the lessor) applies the derecognition and impairment requirements in IFRS 9 to the net investment under finance lease.

Operating lease

Recognition and measurement

Santander Bank Polska S.A. (the lessor) recognises lease payments from operating leases as income on a straight-line basis.

Santander Bank Polska S.A. (the lessor)recognises costs, including depreciation, incurred in earning the lease income as an expense.

Santander Bank Polska S.A., as the lessor, adds initial direct costs incurred in obtaining an operating lease to the carrying amount of the underlying asset and recognises those costs as an expense over the lease term on the same basis as the lease income.

Other items of the statement of financial position

Fixed assets held for sale

On initial date of classification of non-current assets as assets held for sale, Santander Bank Polska S.A. measures them at the lower of carrying amount and fair value less cost to sell.

Potencial reduction of the carrying amount of assets held for sale as at the date of their initial classification as well as subsequent write off to the level of fair value less costs to sell are recognized in the income statement.

Other trade and other receivables

Trade receivables and other receivables with maturity less than 12 months from the origination are measured at the initial recognition at par value due to the immaterial effect of discounting. Trade receivables and other receivables payable within 12 consecutive months are recognised in the amount of the required payment less impairment loss at the balance sheet date.

Other liabilities

Other liabilities payable within 12 months from the initial recognition are measured at par value due to the immaterial effect of discounting. Like other liabilities payable within 12 consecutive months, trade payables are recognised in the amount of the payment due at the balance sheet date.

Equity

Equity comprises capital and funds created in accordance with applicable law, acts and the Articless of Association. Equity also includes retained earnings and accumulated losses.

Share capital is stated at its nominal value in accordance with the Articles of Association and the entry in the court register.

Supplementary capital is created from profit allocations and share issue premiums.

Reserve capital is created from profit allocations and is earmarked for covering balance sheet losses.

The result of valuation of management incentive program is included in reserve capital (IFRS 2.53).

The supplementary, reserve, general banking risk fund and share premium  are presented jointly under category “Other reserve capital”.

Revaluation reserve is comprised of adjustments relating to the valuation of financial assets measured at fair value through other comprehensive income and adjustments relating to the valuation of effective cash flow hedges taking into account deferred tax and actuarial gains from estimating provision for retirement. The revaluation reserve is not distributable.

Except for own equity, non-controlling interests are also recognised in Santander Bank Polska S.A. capital.

On derecognition of all or part of financial assets measured at fair value through other comprehensive income the total effects of periodical change in the fair value reflected in the revaluation reserve are reversed. The value of a given financial asset measured at fair value through other comprehensive income is increased or decreased by the whole amount or an adequate portion of the impairment allowance made previously. The effects of the fair value changes are removed from the revaluation reserve with a corresponding change in the income statement.

The net financial result for the financial year is the profit disclosed in the income statement of the current year adjusted by the corporate income tax charge.

Custody services

Income from custody services is an element of the fee and commission income. The corresponding customer assets do not form part of Santander Bank Polska S.A.’s assets and as such are not disclosed in the consolidated statement of financial position.

Capital payments (Dividends)

Own dividends for a particular year, which have been approved by the General Meeting of Shareholders but not paid at the at the end of the reporting period are recognised as dividend liabilities in “other liabilities” item.

Provisions

A provision is recognised when Santander Bank Polska S.A. has a present legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation. If the amount is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability.

Santander Bank Polska S.A raised  provisions for legal risk  related to contractual clauses in agreements on loans indexed to and denominated in foreign currencies and for reimbursements of portion of fees related to early repayment of consumer loans.

Income statement

Net interest income

Santander Bank Polska S.A. presents the interest income recognised at the effective interest rate and effective interest rate adjusted for credit risk in separate lines of the income statement: “Interest income from financial assets measured at amortised cost” and “Interest income from assets measured at fair value through other comprehensive income”.

In turn, the interest income from financial assets which do not meet the contractual cash flows test is presented in line “Income similar to interest - financial assets measured at fair value through profit or loss”.

Net commission income

Income and expenses from fees and commissions which are not accounted for using the effective interest rate  in such a manner so as to reflect the transfer of the goods or services promised to a customer in an amount reflecting the  consideration to which it will be entitled in return for the goods or services in accordance with the 5 -stage model for recognizing income .

Santander Bank Polska S.A.  identifies separate obligations to perform the service to which Santander Bank Polska S.A.  assigns a transaction price. If the amount of remuneration is variable, the transaction price includes part or all of the variable remuneration to the extent that there is a high probability that there will be no refund of previously recognized revenues. Revenues equal to the transaction price are recognized when the service is performed or when it is performed by providing the customer with the promised good or service. The costs leading to the conclusion of the contract and the costs of performing the contract are activated and then systematically depreciated by  Santander Bank Polska S.A. taking into account the period of transferring goods or services to the customer.The significant commission income of the Santander Bank Polska S.A. includes:

1.      commission income from loans includes fees charged by Santander Bank Polska S.A. in respect of reminders, issued certificates, debt collection, issuing guarantees and for commitment. Due to its nature, the majority of such income is taken to profit or loss on a  one-off basis, i.e. when a specific operation is performed for a customer. Other income, such as a commission for issuing the guarantee, is settled over time during the term of an agreement with a customer.

2.      commission income from credit cards includes fees in respect of card issuance, ATM withdrawals, issuance of a new card, generation of a credit card statement or activation of optional credit card-related services. The vast majority of income is recognised at a specific point in time, i.e. when a specific operation is performed for a customer. Commission in respect of additional services related to credit cards are recognised over time.

3.      Income from asset management is recognised in accordance with a 5-step model based on the value of assets provided to Santander Bank Polska S.A. for management. Pursuant to the agreements in place, Santander Bank Polska S.A. does not receive any upfront fees or additional commissions calculated after the end of the accounting year on the basis of factors beyond the Santander Bank Polska S.A  control.

Net income on bancassurance

For the selected loan products, where linkage to the insurance product has been identified, the Santander Bank Polska S.A. splits realised income into a portion recognised as interest income according to effective interest rate method and a portion recognised as commission income. The Santander Bank Polska S.A. qualifies distributed insurance products as linked to loans in particular if the insurance product influences contractual provisions of a loan.

To determine what part of income is an integral part of the credit agreement recognised as interest income using effective interest rate, the Santander Bank Polska S.A. separates the fair value of the financial instrument offered and the fair value of the intermediation service of insurance product sold together with such instrument.

The portion that represents an element of the amortised cost of the financial instrument and the portion that represents remuneration for the agency services are split in proportion to the fair value of the financial instrument and the fair value of the agency service cost, respectively, relative to the sum of the two values.

The portion of income that is considered an agency fee for sales of an insurance product linked to a loan agreement is recognised by the Santander Bank Polska S.A. as commission income when the fee is charged for sales of an insurance product.

The Santander Bank Polska S.A. verifies the accuracy of the assumed allocation of different types of income at least annually.

Employee benefits

Short-term employee benefits

The Santander Bank Polska S.A.’s short-term employment benefits which include wages, bonuses, holiday pay and social insurance payments are recognised as an expense as incurred.

Long-term employee benefits

The Santander Bank Polska S.A.’s obligation in respect of long-term employee benefits is the amount of future benefits that employees have earned in return for their service in the current and prior periods. The accrual for retirement bonus is estimated using actuarial valuation method. The valuation of those provisions is updated at least once a year.

Equity-settled share-based payment transactions

For equity-settled share-based payment transactions, the Santander Bank Polska S.A  measures the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the Santander Bank Polska S.A. cannot estimate reliable the fair value of the goods or services received,it measures their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted.

Vesting conditions included in the terms of the grant are not taken into account in estimating fair value except where those terms are dependent on market conditions. Non-market vesting conditions are taken into account by adjusting the number of awards included in the measurement of the cost of employee services  in that way at ultimately, the amount recognised in the income statement reflects the number of vested awards.

The expense related to share based payments is credited to shareholder’s equity. Where the share based payment arrangements provide for the issue of new shares, the proceeds of issue of the shares increase share capital and share premium (if any) when awards are exercised.

Cash-settled share-based payment transactions

For cash-settled share-based payment transactions, the Santander Bank Polska S.A. measures the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the Santander Bank Polska S.A. remeasures the fair value of the liability at each reporting date and at the date of settlement, with any changes in fair value recognised in profit or loss for the period. The Santander Bank Polska S.A. recognises the services received, and a liability to pay for those services, as the employees render the service. The liability is measured, initially and at each reporting date until settled, at the fair value of the share appreciation rights, by applying an option pricing model, taking into account the terms and conditions on which the share appreciation rights were granted, and the extent to which the employees have rendered the service to that date.

Trading income and revaluation

Trading income and revaluation include profits and losses resulting from changes in fair value of financial assets and liabilities classified as held for trading that are measured at fair value through profit and loss. Interest cost and income related to the debt instruments are also reflected in the net interest income.

Dividend income

Dividends are taken to the income statement at the moment of acquiring rights to them by shareholders provided that it is probable that the economic benefits will flow to the Santander Bank Polska S.A. and the amount of income can be measured reliably.

Gains on disposal of subsidiaries, associates and join ventures

Gain or loss on the sale of shares in subsidiaries is determined as the difference between the subsidiary’s net asset value adjusted for unwritten-off portion of goodwill and the sale price. Gain or loss on the sale of interests in associates and joint ventures is the difference between the carrying amount and their sale price.

Gain or loss on other financial instruments

Gain or loss on other financial instruments include:

·   gain or loss on disposal of equity instruments and debt instruments classified to the portfolio of financial assets measured at fair value through other comprehensive income; and

·   changes in the fair value of hedged and hedging instruments, including ineffective portion of cash flow hedges.

Santander Bank Polska S.A. uses fair value hedge accounting and cash flow hedge accounting. Details are presented in Note 41 “Hedge accounting”.

Other operating income and other operating costs

Other operating income and costs include operating expenses and revenues, which are not related directly to the statutory activity of the Santander Bank Polska S.A.. These are primarily revenues and costs from the sale and liquidation of fixed assets, income from sale of other services, received and paid damages, penalties and fines.

Impairment losses on loans and advances

The line item “Net impairment losses on loans and advances” presents impairment losses on balance sheet and off-balance sheet exposures and the gains/losses on the sale of credit receivables.

The result on loan receivables’ sale is computed at the assets’ derecognition date from accounts in the difference between carrying value and the amount of remuneration received.

Staff and general and administrative expenses

The “Staff expenses” line item presents the following costs:

·   remuneration and social insurance (including pension benefit contributions);

·   provisions for unused leaves;

·   pension provisions;

·   bonus provisions;

·   the programme for variable components of remuneration paid to individuals holding managerial positions, a part of which is recognised as an obligation on account of share-based payment in cash, in accordance with IFRS 2 Share-Based Payment; and

·   employee training and other salary and non-salary benefits for employees.

The line item “General and administrative expenses” presents the following costs:

·   maintenance and lease of fixed assets;

·   IT and ICT services;

·   administrative activity;

·   promotion and advertising;

·   property protection;

·   short-term lease costs and low-value assets lease cost

·   charges paid to the Bank Guarantee Fund, the Financial Supervision Authority, the National Depository of Securities;

·   taxes and fees (property tax, payments to the National Fund for the Rehabilitation of the Disabled, municipal and administrative fees, perpetual usufruct fees);

·   insurance;

·   repairs not classified as fixed asset improvements.

Tax on financial institutions

Introduced by an act implemented on 1 February 2016, the tax on financial institutions is calculated on the excess of the entity’s total assets over the PLN 4 billion level; in the case of banks the excess results from the statement of turnover and balances at the end of each month. Banks are permitted to reduce the tax base by e.g. the value of own funds and the value of treasury securities. In addition, banks reduce the tax base by the value of assets purchased from the National Bank of Poland held as collateral for a refinancing credit facility granted by the latter. The tax rate for all taxpayers is 0.0366% per month, and the tax is paid monthly by the 25th day of the month following the month it relates to. Santander Bank Polska S.A. reports the tax charge under “Tax on financial institutions”, separately from the income tax charge.

Corporate income tax

Corporate income tax comprises current and deferred tax. Income tax is recognised in income statement except for items that are recognized in equity.

Current tax is the tax payable on the taxable income for the year using tax rates enacted or substantively enacted at the end of the reporting period and any adjustment to tax payable in respect of previous years.

Deferred  tax assets and liabilities are provided, using the balance sheet method, on temporary differences between the tax bases of assets and liabilities and their values arising from the statement of financial position. Deferred income tax is determined using tax rates based on legislation enacted or substantively enacted at the end of the reporting period and expected to apply when the deferred tax asset is realised or the deferred tax liability is settled. Deferred tax assets are recognised at realizable amount – it is to the extent that is probable that the Santander Bank Polska S.A. generates taxable profit allowing partial or wholly realisation of deferred tax assets. The carrying value of deferred tax assets is verified at the end of each reporting period. The Santander Bank Polska S.A. reduces the carrying amount of the deferred tax asset to the realizable value - that is, to the extent that it is probable that taxable income will be sufficient to partially or fully realize the deferred tax asset.

Deferred and current tax assets and liabilities are only offset when they arise in the same tax reporting group and where there is both the legal right and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously.

3.   Risk management

Santander Bank Polska S.A. is exposed to a variety of risks in its ordinary business activities. The objective of risk management is to ensure that the Bank takes risk in a responsible and controlled manner when maximising the value for shareholders. Risk is a possibility of materialisation of events impacting the achievement of the Bank’s strategic goals.

Risk management policies are designed to identify and measure risk, define the most profitable return within the accepted risk level (risk-reward), and to continually set appropriate risk mitigation limits. Santander Bank Polska S.A. modifies and develops risk management methods on an ongoing basis, taking into consideration changes in the Group’s risk profile, economic environment, regulatory requirements and best market practice.

The Management Board and Supervisory Board set the business direction and actively support the risk management strategies. This is achieved by defining the risk management and risk appetite strategy, as well as approving the key risk management policies, participation of the Management Board Members in the risk management committees, reviewing and signing off on the key risks and risk reports.

The Supervisory Board continuously oversees the risk management system. The Supervisory Board approves the strategy, key risk management policies and risk appetite, and monitors the use of internal limits in relation to the current business strategy and macroeconomic environment. It conducts the reviews of the key risk areas, the identification of threats and the process of defining and monitoring remedial actions. The Supervisory Board assesses if the control activities performed by the Management Board are effective and aligned with the Supervisory Board’s policy. The assessment also includes the risk management system.

The Audit and Compliance Committee supports the Supervisory Board in fulfilment of its oversight obligations. The Committee performs annual reviews of the Bank’s financial controls, and receives reports from the independent audit function and the compliance function. The Committee also receives quarterly reports on the degree of implementation of post-audit recommendations, and on that basis evaluates the quality of the actions taken. The Committee assesses the effectiveness of internal control system and risk management system. Moreover, the Committee monitors financial audits, in particular inspections carried out by the audit company, controls, monitors and assesses independence of the chartered auditor and audit company, and reports the outcomes of inspections to the Supervisory Board. In addition, the Committee develops the policy and procedure for selecting the audit company and presents to the Supervisory Board the recommendations on election, re-election and recalling of External Auditor and on the External Auditor’s fee.

The Risk Committee supports the Supervisory Board in assessing the effectiveness of the internal control and risk management systems and measures adopted and planned to ensure an effective management of material risks.

Moreover,in the Bank the Supervisory Board is also supported by the Remuneration Committee and the Nominations Committee, however outside the risk management area.

The Management Board is responsible for the effectiveness of risk management. In particular, it introduces the organisational structure aligned with the level and profile of the risk being undertaken, split of the responsibilities providing the separation of the risk measurement and control function from the operational activity, implements and updates the written risk management strategies, and ensures transparency of the activities. The Management Board reviews the

financial results of the Bank. It established a number of committees which are directly responsible for the development of the risk management methodology and monitoring of risks in particular areas.

The Management Board fulfils its risk management role also through the following committees: Risk Management Committee and Risk Control Committee, where the Management Board members are supported by key risk management officers.

The Risk Management Committee approves the key decisions taken by the lower-level risk committees (above established limits), approves annual limits for securities transactions as well as ALCO limits and plans for risk assessing models.

The Risk Control Committee monitors the risk level across different areas of the bank’s operations and supervises the activities of lower-level risk management committees set up by the Management Board. These committees, acting within the respective remits defined by the Management Board, are directly responsible for developing risk management methods and monitoring risk levels in specific areas.

The Risk Control Committee supervises the activities of the below-listed committees operating in the risk management field:

The Risk Management Forum, which approves and supervises risk management policy and risk measurement methodology as well as monitors credit risk, models’ risk, market risk on the banking book, market risk on the trading book, structural risk for the balance sheet and liquidity risk. The Forum operates through three competency panels:

·       Credit Risk Panel

·       Market and Investment Risk Panel

·       Models and Methodology Panel.

The Credit Committee takes credit decisions within the assigned lending discretions.

The Provisions Committee takes decisions on impairment charges in an individual and collective approach, for credit exposures, as well as other financial instruments and assets and on legal risk provisions. Moreover, the Committee formulates the methodology, reviews and verifies the adequacy of parameters applied when setting the impairment in an individual and collective approach for Santander Bank Polska SA, excluding Santander Consumer Bank.

The Information Management Committee is responsible for the quality and organisation of data related to risk management and other areas of the bank’s operations.

The Operational Risk Management Committee (ORMCo) monitors the level, sets the direction for strategic operational risk actions in Santander Bank Polska SAin the area of business continuity, information security and fraud prevention.

CyberTechRisk Forum is responsible for the evaluation and proposing changes to the IT, cybersecurity and operations strategy as well as for the monitoring of key issues related to IT, cybersecurity and operations. The Committee is also a forum for discussion on operational risk with focus on technological risk, including cyber risk;

Suppliers Panel establishes standards and carries out monitoring regarding providers and services, incl. outsourcing; main forum for discussion on risk resulting from the cooperation with suppliers.

The Assets and Liabilities Management Committee supervises the activity on the bank’s and the Group’s banking book, manages liquidity and interest rate risk in the banking book and is responsible for the funding and balance sheet management, including for the pricing policy.

Liquidity Forum monitors liquidity position of the Bank, with a special focus on the dynamics of deposit and credit volumes, the Bank’s needs for financing and the general market situation.

The Capital Committee is responsible for capital management, in particular the ICAAP.

The Disclosure Committee verifies if the financial information published by Santander Bank Polska SA meets the legal and regulatory requirements.

The Local Marketing and Monitoring Committee approves new products and services to be implemented in the market, taking into  account the reputation risk analysis.

The General Compliance Committee is responsible for setting standards with respect to the management of compliance risk and the codes of conduct adopted in the Bank.

The Regulatory and Reputational Risk Committee is responsible for monitoring and taking decisions on cases relating to the compliance with law, regulatory guidelines and market/ industry standards relating to the business.

The Anti-Money Laundering and Counter-Terrorism Financing Committee approves the bank’s policy on prevention of money laundering and the financing of terrorism. It approves and monitors the Group’s activities in this area.

The Recovery Committee takes decisions regarding corporate clients with financial difficulties, including with respect to the relationship management strategy, approval of the causes of loss analysis and monitoring of the portfolio and effectiveness of recovery processes.

The chart below presents the corporate governance in relation to the risk management process.

Risk management is in line with the risk profile resulting from risk appetite. At Santander Bank Polska risk appetite is expressed as quantitative limits and captured in the “Risk Appetite Statement” adopted by the Management Board and approved by the Supervisory Board. Global limits are used to set watch limits and shape risk management policies.

Bank continuously analyses the risks to which it is exposed in its operations, identifies their sources, creates the relevant risk management mechanisms including among others the measurement, control, mitigation and reporting. The key risks include:

·       credit risk

·       concentration risk

·       market risk in the banking book and trading book

·       liquidity risk

·       operational risk,

·       compliance risk.

Detailed rules, roles and responsibilities of the Group companies are set out in relevant internal policies relating to the management of individual risk types.

Santander Bank Polska SA pays special attention to the consistency of risk management processes across the Group, which ensures adequate control of the risk exposure. The subsidiaries implement risk management policies and procedures reflecting the principles adopted by Santander Bank Polska SA.

Acting under the applicable law, the bank exercises oversight of risk management in Santander Consumer Bank in line with the same oversight rules as applied to other Santander Bank Polska Group companies. The bank’s representatives on the Supervisory Board of Santander Consumer Bank are: the Management Board member in charge of the Risk Management Division and the Management Board member in charge of the Retail Banking Division. they are responsible for supervision over Santander Consumer Bank S.A. and they ensure, together with the company’s Supervisory Board, that the company operates in line with adopted plans and operational security procedures. The bank monitors the profile and level of Santander Consumer Bank S.A. risk via risk management committees of Santander Bank Polska S.A.

Credit risk

Santander Bank Polska S.A. credit activities focus on growing of a loan portfolio while guaranteeing its high quality, a good yield and customer satisfaction.

Credit activity includes all products subject to credit risk (credit facilities), originated by the Bank or its leasing and factoring subsidiaries.

Credit risk is defined as the possibility of suffering a loss as a result that a borrower will fail to meet its credit obligation, including interest and fees. Credit risk arises from the impairment of credit assets and contingent liabilities, resulting from worsening of the borrower’s credit quality. Credit risk measurement is based on the estimation of credit risk weighted assets, with the relevant risk weights representing both the probability of default and the potential loss given default of the borrower.

Bank’s credit risk arises mainly from lending activities on the retail, SME, business, corporate and interbank markets. This risk is manager as part of the policy approved by the Management Board on the basis of the adopted credit procedures as well as on the basis of discretionary limits allocated to individual credit officers based on their knowledge and experience. The internal monitoring system and credit classification used by the Bank allows for an early identification of situations threatening the deterioration of the quality of the loan portfolio. Additionally the bank uses large set of credit risk mitigation tools, both collaterals (financial and non-financial) and specific credit provisions and clauses (covenants).

The bank continues to develop and implement risk based methods of grading loans, allocating capital and effectiveness measurement. Risk valuation models are used for all credit portfolios.

The bank also continues to review processes and procedures of measuring, monitoring and managing of credit portfolio risk adjusting them to the revised regulatory requirements, especially to Recommendations of KNF and EBA.

In 2020 the bank is closely looking at the macroeconomic environment and analysing its credit exposure to particular customer segments and economic sectors to respond with an adequate and prompt action and adjust its credit policy parameters accordingly.

In 2020, the bank focused intensly on tackling the threats posed by the Covid-19 pandemic. An increased focus was placed on risk indicators in credit portfolios amid the Covid-19 outbreak and the lockdown of many economic activities. Appropriate management reports were expanded in order to identify institutional customers in financial distress due to the Covid-19 pandemic. Early warning systems as well as early restructuring measures were strengthened to cushion the effects of economic slowdown.

The bank benefitted from the government anti-crisis support programmes for customers affected financially by the COVID-19 pandemic. At the same time, the Bank contributed to and adopted a special moratorium developed by the banking sector under the auspices of the Polish Bank Association, which laid down uniform rules for offering tools to aid those customers. In consequence, numerous internal regulations and processes were adapted as a matter of urgency.

Risk Management Forum

The credit risk oversight in Santander Bank Polska S.A. is performed by Credit Policy Panel (CPP) operating within the Risk Management Forum. Its key responsibilities include development and approval of the best sectoral practice, industry analyses, credit policies as well as implementation of grading and assessment systems aimed at ensuring sustainable growth of the credit portfolio. To align the bank’s management processes with the current strategic goals, three sub-committees were established within the CPP with a responsibility for the key customer segments: retail segment, SME segment and the business/corporate segment. The oversight over the credit risk models is the responsibility of the Models and Methodology Panel.

Risk Management Division

The Risk Management Division is responsible for a consolidated credit risk management process, including management and supervision of credit delivery, defining credit policies, providing decision-making tools and credit risk measurement tools, quality assurance of the credit portfolio and provision of reliable management information on the credit portfolio.

Credit Policies

Credit policies refer to particular business segments, loan portfolios and banking products. They contain guidelines for the identification of the areas where specific types of risks manifest themselves, specifying the methods of their measurement and mitigation to the level acceptable to the bank (e.g. “Loan-to-Value” ratios, FX risk in the case of foreign currency loans).

The bank reviews and updates its credit policies on a regular basis, aiming to bring them in line with the bank’s strategy, current macroeconomic situation, legal developments and changes in regulatory requirements.

Credit Decision Making Process

The credit decision-making process as a part of the risk management policy is based upon Individual Credit Discretions vested in credit officers, commensurate with their knowledge and experience within the business segments. Credit exposures in excess of PLN 25m are referred to the Credit Committee composed of senior management and top executives. Transactions above established thresholds (from PLN 48.75m to PLN 195m, depending on the transaction type) are additionally ratified by Risk Management Committee.

Bank continually strives to ensure best quality credit service while satisfying the borrowers’ expectations and ensuring security of the credit portfolio. To this end, the credit risk approval function has been segregated.

Credit Grading

Santander Bank Polska S.A. dynamically developes credit risk assessment tools to conform to the recommendations of the Polish Financial Supervision Authority, the International Accounting Standards/International Financial Reporting Standards and the best practice in the market.

Bank uses credit risk grading models for its key credit portfolios, including corporate customers, SMEs, mortgage loans, property loan, cash loans, credit cards and personal overdrafts.

The bank regularly monitors its credit grading using the rules specified in its Lending Manuals. Additionally, for selected models, automated process of credit grade verification is carried out based on the number of overdue days or an analysis of the customer’s behavioural data. Credit grade is also verified at subsequent credit assessments.

Credit Reviews

The bank performs regular reviews to determine the actual quality of the credit portfolio, confirm that adequate credit grading and provisioning processes are in place, verify compliance with the procedures and credit decisions and to objectively assess professionalism in credit management. The reviews are performed by the two specialised units: Credit Review Department and the Control Department, which are independent of the risk-taking units.

Collateral

In the Santander Bank Polska S.A. security model, the Collateral and Credit Agreements Department is the central unit responsible for creation and maintenance of securities. The Security Manual as a procedure describing legal standards for the application of collateral security is managed by the Legal and Compliance Division. The Collateral and Credit Agreements Department is the owner of the security contract templates.

The role of the department is to ensure that security covers are duly established and held effective in line with the lending policy for all business segments. The unit is also responsible for developing standardised internal procedures with respect to perfecting and maintaining validity of collateral as well as ensuring that establishment, monitoring and release of security covers is duly effected.

Furthermore, the Collateral and Credit Agreements Department provides assistance to credit units in credit decision making and development of credit policies with respect to collateral. The unit gathers data on collateral and ensures appropriate management information. The tables below show types of collateral that can be used to secure loans and advances to customers from non-banking sector.

Retail customers

Business customers

Collateral management process

Before a credit decision is approved, in the situations provided for in internal regulations, the Collateral and Credit Agreements Department assesses the collateral quality, a process that includes:

·       verification of the security valuation prepared by external valuers, and assessment of the security value,

·       assessment of the legal status of the security,

·       assessment of the investment process for the properties,

·       seeking legal advises on the proposed securities.

The Collateral and Credit Agreements Department actively participates in credit processes, executing tasks including:

·       verification of signed collateral documentation received from law firms, whether complete and compliant with the Bank’s internal procedures (verification carried out before or immediately after disbursement);

·       registration and verification of the data in information systems,

·       collateral monitoring and reporting,

·       reporting on the status of collateral by segments,

·       releasing of the collateral.

In managing its receivables, Bank carries out the process of collateral execution. Selection of proper action towards execution of specific collateral depends on the type of the collateral (personal or tangible). In principle the Bank aims at voluntary proceedings in the course of collateral execution. When there is no evidence of cooperation with a collateral provider, the bank’s rights are fulfilled in compliance with the law and internal regulations in the bankruptcy and enforcement proceedings.

Financial effect of the accepted collateral

The financial effect of the accepted collateral was calculated as a change in the credit loss allowance as a result of exclusion of the cash flow from collateral (non-performing exposures are assessed on an case-by-case basis). For other portfolios (mortgage, SME and corporate loans), this effect was calculated by adjusting the LGD parameter to the level observed for particular clients on unsecured products.

The table below present financial effect of collateral of Santander Bank Polska S.A. as at 31.12.2020:

The table below present financial effect of collateral of Santander Bank Polska S.A. as at 31.12.2019:

Credit risk stress testing

Stress testing is a part of the credit risk management process used to evaluate potential effects of specific events or movement of a set of financial and macroeconomic variables or change in risk profile on Santander Bank Polska condition. Stress tests are composed of assessment of potential changes in credit portfolio quality when faced with adverse conditions. The process also delivers management information about adequacy of agreed limit and internal capital allocation.

Impairment calculation

Santander Bank Polska posts impairment for expected losses in accordance with International Financial Reporting Standard 9 (IFRS 9). IFRS 9 introduced a new approach to the estimation of allowances for credit losses. The approach is based on estimation of the expected credit loss (ECL). ECL allowances reflect an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes, the time value of money; and reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions. ECL allowances are measured at an amount equal to a 12-month ECL or the lifetime ECL, when it is deemed there has been a significant increase in credit risk since initial recognition. Accordingly, the ECL model gives rise to measurement uncertainty, especially in relation to:

·       measurement of a 12-month ECL or the lifetime ECL;

·       determination of when a significant increase in credit risk occurred;

·       determination of any forward-looking events reflected in ECL estimation, and their likelihood.

In accordance with IFRS 9, the recognition of expected credit losses will depend on changes in risk after recognition of the exposure. The standard introduces three main stages for recognising expected credit losses:

·       Stage 1 – exposures with no significant increase in risk since initial recognition, i.e. the likelihood of the exposure being downgraded to the impaired portfolio (Stage 3 exposures) has not increased. For such exposures, 12-month expected credit losses will be recognised.

·       Stage 2 – exposures with a significant increase in risk since initial recognition, but with no objective evidence of default. For such exposures, lifetime expected credit losses will be recognised.

·       Stage 3: exposures for which the risk of default has materialised (indications of impairment have been identified). For such exposures, lifetime expected credit losses will be recognised.

Lifetime expected losses are recognised also for the exposures classified as POCI (purchased or originated credit-impaired).

In the case of classification into stage 3, the bank applies objective indications of impairment, as defined in accordance with the Basel Committee's recommendations and Recommendation R. The bank did not introduce any material changes in respect of IFRS 9 implementation.

The bank estimates ECL using both an individual approach (for individually significant exposures with objectively evidenced impairment [stage 3]) and collective approach (individually insignificant exposures with objectively evidenced impairment, and incurred but not reported losses).

Twice a year, the Bank recalibrates its models and updates the forward-looking information used for estimating ECL, taking into account the impact of changes in economic conditions, modifications of the Bank’s credit policies and recovery strategies, which is designed to ensure appropriate level of impairment allowances.

The tables below present Santander Bank Polska SA exposure to credit risk.

Assets have been classified into respective risk grades based on the one-year probability of default arising from current credit rating (business customers) or score (personal customers) used for the purpose of business processes or, if not available, based on the one-year probability of default used for calculation of expected credit losses. Non-impaired assets (stages 1 and 2) have been divided into five categories (very good, good, average, acceptable, weak).

Limits of individual categories depend on the type of receivables, are presented in the table below:

The tables below present the quality of ‘Loans and advances to business customers measured at fait value through other comprehensive income’ broken down into stages as at 31.12.2020 and in the comparative period:

The tables below present the quality of financial assets of Santander Bank Polska broken down into stages and by ratings as at December 31, 2020 and in the comparative period:

There are no instruments classified to Stage 2 as at 31.12.2019.

Loans and advances to banks are assessed using ratings. The assessment method was set out in the Bank’s internal regulations. Each institutional client (exposure) is assigned a rating by one of the reputable rating agencies (Fitch, Moody’s, S&P), in accordance with the CRR. Then, a relevant grade is allocated to the client. There are no overdue or impaired loans and advances to banks.

Financial instruments from the investment securities measured at fair value and held-for-trading portfolio are assessed in accordance with the sovereign rating (treasury bonds, securities issued by the National Bank of Poland [NBP], Bank Gospodarstwa Krajowego [BGK] debt instruments). The sovereign rating is the same as the NBP/BGK rating. All have the same rating as Poland, according to Fitch it is A-.

For all instruments classified to Stage 1 (including also loans and advances to customers measured at fair value through other comprehensive income), there is no overdue or impairment, therefore they are classified to Stage 1. In accordance with its definition- as exposures with no significant increase in risk since initial recognition, i.e. the likelihood of the exposure being downgraded to the impaired portfolio (Stage 3) has not increased. For such exposures, 12-month expected credit losses will be recognized.

The significant majority of exposures at fair value through other comprehensive income (99.2%) were classified as credit quality - 'average'. However, 95% of the Bank's credit card portfolio at fair value through profit or loss was rated 'average' or above (good, very good).

Credit exposures with assistance tools due to COVID-19

In connection with the crisis caused by the COVID-19 pandemic, Santander Bank Polska S.A. offered its clients a number of assistance tools aimed at temporarily reducing their financial liabilities.

The range of tools included:

1)     debt moratoria resulting from the banks' position regarding the unification of the rules for offering aid tools to clients of the banking sector (i.e. non-legislative moratorium within the meaning of the guidelines of the European Banking Authority (EBA)),

2)     Anti-Crisis Shield 4.0.

3)     financing to stabilize the liquidity situation, under which BGK collaterals were used

The table below presents data on the assistance tools provided by the Bank as part of initiatives aimed at mitigating the negative effects of the COVID-19 epidemic by 31 December 2020.

The table below shows the size of the provided assistance tools in the form of statutory and non-statutory moratoria as at 31 December 2020.

Debt moratoria resulting from COVID-19 do not automatically result in the derecognition of financial instruments. Modifications resulting from the support provided to clients under the statutory and non-statutory programs resulting from COVID-19 were assessed in accordance with the qualitative and quantitative criteria applied by Bank, as described in point 2.9 of presented financial statements.

Santander Bank Polska S.A. recognized by 31 December 2020, PLN 20 579 k, as a reduction in interest income that is a reduction in the gross carrying amount due to modifications that do not result in the derecognition of financial instruments.

In accordance with adopted criteria, for assessing modifications, Bank identified a small percentage of modifications resulting from COVID-19 as modifications leading to derecognition of financial instruments.

The table below presents information on modified financial assets that do not result in derecognition from the balance sheet, for which the allowance for expected credit losses was calculated over the lifetime of the exposure.

Credit risk concentration

Santander Bank Polska adheres to the standards provided for in the Banking Law with regard to the concentration of risk bearing exposures to a single entity or a group of entities connected in terms of capital or organisation. As at 31.12.2020, pursuant to art. 71 of the Banking Law Act, the maximum limits for the Bank amounted to:

·       PLN 6 338 618 k (25% of Bank’s own funds).

As at 31.12.2019, pursuant to art. 71 of the Banking Law Act, the maximum limits for the Bank amounted to:

·       PLN 5,601,427 k (25% of Bank’s own funds).

The policy pursued by the Bank aims at minimising the credit concentration risk, by for example applying more rigorous than regulatory rules in this respect. The effect of this policy is maintenance of high level of diversification of exposures towards individual customers.

The analysis of the Bank’s exposures in terms of sector concentrations, proved that the bank does not have any exposures in excess of the limits imposed by the regulator in 2020.

A list of the 20 largest borrowers (or capital-related group of borrowers) of Santander Bank Polska S.A. (performing loans) as at 31.12.2020:

A list of the 20 largest borrowers (or capital-related group of borrowers) of Santander Bank Polska S.A. (performing loans) as at 31.12.2019:

Industry concentration

The credit policy of Santander Bank Polska S.A. assumes diversification of credit exposures. Risk of particular industry affects value of the exposure limit. In order to ensure adequate portfolio diversification and control the risk of overexposure to a single industry, the Group provides funding to sectors and groups or capital units representing a variety of industries.

As at 31.12.2020, the highest concentration level was recorded in the “distribution” sector (10% of the Santander Bank Polska exposure), “Financial sector” (9%) and “property” (8%).

Groups of PKD by industries:

Market risk

Introduction

Market risk is defined as an adverse earnings impact of changes in interest rates, FX rates, share quotations, stock exchange indices, etc. It arises both in trading and banking activity (FX products, interest rate products, equity linked trackers).

Santander Bank Polska is exposed to market risk arising from its activity in money and capital markets and services provided to customers. Additionally, the bank undertakes the market risk related to the active management of balance sheet structure (assets and liabilities management).

The activity and strategies on market risk management are directly supervised by the Risk Management Forum and are pursued in accordance with the framework set out in the Market Risk Policy and the Structural Risk Policy approved by the Management Board and the Supervisory Board.

Risk management structure and organisation

The key objective of the market risk policy pursued by the Bank is to reduce the impact of variable market factors on the bank’s profitability and to grow income within the strictly defined risk limits while ensuring the bank’s liquidity and market value.

The market risk policies of Santander Bank Polska establish a number of risk measurement and mitigation parameters in the form of limits and metrics. Risk limits are periodically reviewed to align them with the bank’s strategy.

Interest rate and FX risks linked to the banking business are managed centrally by the Financial Management Division. The Division is also responsible for acquiring funding, managing liquidity and making transactions on behalf of ALCO. This activity is controlled by the measures and limits approved by the Risk Management Forum, the bank’s Management Board and the Supervisory Board.

The debt securities and the interest rate and FX hedging portfolio is managed by ALCO, which takes all decisions on the portfolio’s value and structure.

The market risk on the trading portfolio is managed by the Corporate and Investment Banking Department, which is also responsible for the activities of Santander Brokerage Poland. The Group’s trading activity is subject to a system of measures and limits, including Value at Risk, stop loss, position limits and sensitivity limits. These limits are approved by the Risk Management Forum, the bank’s Management Board and the Supervisory Board.

The Financial Risk Department within the Risk Management Division is responsible for ongoing risk measurement, implementation of control procedures and risk monitoring and reporting. The Department is also responsible for shaping the market risk policy, proposing risk measurement methodologies and ensuring consistency of the risk management process across the Group. Owing to the fact that the Department is a part of the Risk Management Division, the risk measurement and monitoring processes are separate from the risk-taking units.

The market risk of equity instruments held by Santander Brokerage Poland (shares, index-linked securities) is managed by Santander Brokerage Poland itself and supervised by the Risk Management Forum of Santander Bank Polska S.A.

The bank’s Risk Management Forum, chaired by the Management Board member in charge of the Risk Management Division, is responsible for independent control and monitoring of market risk in the banking and trading books.

Risk identification and measurement

The trading book of Santander Bank Polska contains securities and derivatives held by the Corporate and Investment Banking Division for trading purposes. The instruments are marked to market each day, and any changes in their value are reflected in the profit and loss. Market risk in the trading book includes interest rate risk, currency risk and repricing risk.

The interest rate risk in the bank’s banking book is the risk of adverse impact of interest rate changes on the Group’s income and the value of its assets and liabilities. Interest rate risk arises primarily on transactions entered in the bank’s branches and in the business and corporate centres, as well as the transactions made in the wholesale market by the Financial Management Division. Additionally, interest rate risk can be generated by transactions concluded by other units, e.g. through acquisition of  municipal/ commercial bonds or the bank’s borrowings from other sources than the interbank market.

Santander Bank Polska uses several methods to measure its market risk exposure. The methods employed for the banking portfolio are the MVE and NII sensitivity measures, stress tests and Value at Risk (VaR), while the methods used for the

trading portfolio include: VaR and stressed VaR, stop loss, sensitivity measures (PV01) and stress tests. The risk measurement methodology is subject to an independent initial and periodic validation, the results of which are presented for approval to the Models and Methodology Panel (part of the Risk Management Forum).

At Santander Bank Polska, the VaR in the trading portfolio is determined using a historical method as a difference between the mark-to-market value of positions and the market values based on the most severe movements in market rates from a determined observation window. VaR is calculated separately for interest rate risk, FX risk and the two risks at the same time. VaR is also calculated for the repricing risk of the equity instruments portfolio of Santander Brokerage Poland.

Due to the limitations of the VaR methodology, the bank additionally performs sensitivity measurement (showing how position values change in reaction to price/profitability movements), Stressed VaR measurement and stress tests.

Risk reporting

The responsibility for reporting liquidity risk rests with the Risk Management Division, specifically the Financial Risk Department.

Each day, the Financial Risk Department controls the market risk exposure of the trading book in accordance with the methodology laid down in the Market Risk Policy. It verifies the use of risk limits and reports risk levels to units responsible for risk management in the trading book, to Santander Group and to the Risk Management Forum. 

Once a month, the Financial Risk Department provides information about the risk exposure of the trading book and selected measures to the Risk Management Forum and prepares the Risk Dashboard (in cooperation with other units of the Risk Management Division), which is presented to the Risk Management Committee.

The results of market risk measurement with regard to the banking book are reported by the Financial Risk Department to persons responsible for operational management of the bank’s balance sheet structure and to persons in charge of structural risk management on a daily basis (information about the ALCO portfolio) or on a monthly basis (interest rate gap, NII and MVE sensitivity measures, stress test results, VaR). This information is also reported each month to the bank’s senior executives (Risk Management Forum, ALCO). The selected key interest rate risk measures, including risk appetite measures defined for the bank’s banking book, are reported to the bank’s Management Board and Supervisory Board.

Risk prevention and mitigation

The Bank has adopted a conservative approach to  risk-taking both in terms of the size of exposures and the types of products. A large portion of the Financial Market Area activity revolves around  mitigating the risk  related to customer transactions at  the retail and corporate level.  In addition, flows from customer transactions are generally for non-market amounts and tenors and thus risk capacity is required to manage these mismatches with wholesale transactions.

From the Bank’s perspective, the market risk limits are small and are in place to allow sufficient capacity and time to neutralise interest rate and foreign exchange risks, while at the same time allowing the Financial Market Area to hold some of portfolio positions opened to add value to the organisation. 

There is a greater emphasis placed on market making over pure mark to market trading and this is reflected in both limit utilisation and budgetary targets of Financial Market Area.

The combination of transactions made by the Financial Market Area and positions transferred from the bank arising from customers’ FX and derivative activity create the overall interest rate and currency risk profilesin the bank’s trading portfolio, which are managed under the market risk policy and operational limits in place. The Financial Market Area subsequently decides either to  close these positions or keep them open in line with market view and approved limits. The return earned is a mix of flow management and market making. However, there is no intention to keep aggressive trading positions.

The interest rate and currency risk of the Financial Market Area is managed via the trading book in accordance with the Market Risk Policy approved by the Management Board. Accounting and risk systems help to ensure  allocation of each position into appropriate books. The relevant desks are responsible for suitable risk activity (interest rate or currency risk).

To ensure that the trading book positions are marketable, the bank controls the gross value of the positions (separately long and short positions) versus the entire market. This is to check if it is technically possible to close an open position one way, without taking into account other closings. The control is performed by the Financial Risk Department separately for currency positions and interest rate positions.  The control results are reported to the Financial Market Area.

As regards market risk in the banking book, all positions that generate repricing risk are transferred for management to the Financial Management Division, responsible for shaping the bank’s balance sheet structure, including by entering into

transactions in the interbank market so as to manage the interest rate risk profile according to the approved risk strategy and in compliance with the allocated risk limits.

The interest rate risk in the banking book is managed based on the following limits: 

·       NII sensitivity limit (the sensitivity of net interest income to a parallel shift of the yield curve by 100 bp);

·       MVE sensitivity limit (the sensitivity of the market value of equity to a parallel shift of the yield curve by 100 bp).

The sensitivity measures for 2020 and 2019 are shown in the table below. It presents the results of scenarios, in which the impact of changes in interest rates on interest income and the economic value of capital would be negative.

In 2020, the interest rate risk limits, notably the MVE sensitivity limit, were utilised to a larger extent due to dynamic growth in the balance and stable part of the non-interest bearing and non-maturity deposit portfolio resulting from interest rate cuts and inflow of funds as part of state aid schemes connected with the Covid-19 pandemic. The above factors caused the operational MVE limit to be incidentally exceeded in Q2 2020. This issue was escalated in accordance with the Structural Risk Management Policy and subsequently closed through increased investments made by the Bank in fixed-rate assets.

VaR in the banking portfolio is calculated separately as a combined effect of EaR (Earnings-at-Risk) and EVE VaR (value at risk of the economic value of equity).

The key methods of measurement of the interest rate risk in the trading book include the VaR methodology, stop loss, PV01 sensitivity measurement and stress tests.

The VaR is set for open positions of the Financial Market Area using the historical simulations method. Under this method the bank estimates the portfolio value of 520 scenarios generated on the basis of historically observable changes in market parameters. VaR is then estimated as the difference between the current valuation and the valuation of the 99th percentile of the lowest valuations.

The stop-loss mechanism is used to manage the risk of loss on positions subject to fair value measurement through profit or loss.

Stress tests are used in addition to these measures by providing an estimate of the potential losses in the event of materialisation of the stressed conditions in the market. The assumptions of stress scenarios are based on sensitivity reports and on extreme market rate movement scenarios set using the highest daily and monthly changes in interest rates.

The table below shows risk measures at the end of 2020 and 2019 for 1-day position holding period:

Higher maximum IR VaR reported in 2020 resulted from the Bank’s engagement in financial support programmes organised by BGK and PFR in connection with COVID-19 – consequently, the Bank had to maintain temporary positions on bonds issued by BGK and PFR in its trading book. The maximum observable VAR levels above the permissible limit were accepted by the Supervisory Board.

FX risk is the risk that adverse movements in foreign exchange rates will have an impact on performance (and result in losses).  This risk is managed on the basis of the VaR limit for the open currency positions in the Group’s trading portfolio and the portfolio of Santander Brokerage Poland which manages open positions linked to the market maker activity. Stress tests are used in addition to this measure by providing an estimate of the potential losses in the event of materialisation of the stressed conditions in the market. Stress tests use the currency exposure and the scenarios of extreme movements in

currency rates based on historical data. Furthermore, the stop-loss mechanism is used for managing the risk of losses on trading positions.

In accordance with its policy, the Bank does not maintain open positions on currency options. Transactions made with customers are immediately closed in the interbank market thus limiting the Group’s exposure to the market risk on the currency options portfolio.

Open FX positions of subsidiaries are negligible and are not included in the daily risk estimation. In the case of Santander Consumer Bank S.A., it has a separate banking license and independently manages risk, which management is controlled by the Risk Management Forum of Santander Bank Polska.

The table below illustrates the risk measures at the end of December 2020 and 2019.

In 2020, the VaR limit for currency risk was not exceeded.

As regards the structural exposure to currency risk in the bank’s balance sheet, in 2020 the share of foreign currency assets in the bank’s balance sheet continued to decrease. This was affected by the increase in the value of of investment financial assets and the gradual decrease in the balance of CHF loans as a result of the continuing expiting of the CHF mortgage portfolio.

The resulting funding gap relating to individual currencies was closed by entering into swap transactions in the FX market.

The tables below present the bank’s key FX positions as at 31 December 2020 and in the comparable period.

The risk attached to the prices of equity instruments listed in active markets is managed by Santander Brokerage Poland, which operates within the Corporate and Investment Banking Division.  This risk is generated by own trades of Santander Brokerage Poland concluded in regulated markets (spot market instruments and futures).

It is measured using a Value at Risk model based on the historical analysis method.

The market risk management in Santander Brokerage Poland is supervised by the Risk Management Forum of Santander Bank Polska S.A. The Forum sets the VaR limit for Santander Brokerage Poland, approves changes in the risk measurement methodology and oversees the risk management process.

The table below presents the risk measures in 2020 and 2019.

In 2020, the VaR limit for equity risk was not exceeded.

Interest Rate Benchmark reform

In connection with the entry into force of the regulation of the European Parliament of July 2016 (2016/1011) regarding indices used as benchmarks for financial instruments and financial contracts (BMR Regulation) and the decision to terminate by the end of 2021 LIBOR indices calculation by ICE Benchmark Administration Limited (IBA), Santander Bank Polska launched a development program aimed at preparing the Bank for changes resulting from these decisions (IBOR Program).

In particular, the IBOR Program focuses on changes necessary to introduce new products based on interest rate indices compliant with the BMR Regulation, in particular indices replacing the interim LIBOR (mainly GBP, CHF and USD). At the same time, work is underway to prepare the Bank to introduce changes to transactions concluded with a maturity date / time after December 31, 2021, i.e. after the date of cessation of the LIBOR calculation.

As part of the IBOR Program, the Bank analyzed the currently pending transactions in terms of the existing contractual provisions on the use of alternative indices, joined the revised version of the ISDA protocol and changed the settlement of margins in EUR and USD at clearing houses by switching to new indices.

In the next steps, activities are planned to prepare IT systems, processes, new contract templates for individual products, risk assessment methods and valuation models. The Bank is preparing with particular care to changes in the scope of consumers.

Works under the IBOR Program are mainly carried out by a wide group of experts representing all the Bank's business lines, supported by experts from reputable consulting companies, under the supervision of the Steering Committee composed mainly of members of the Management Board and top management.

Works at Santander Bank Polska S.A. are coordinated with preparations underway both in the subsidiaries and at the level of the entire Santander group.

The ongoing works on the change in the BMR regulations and the working groups working on the development of alternative indicators, which may have a significant impact on the risk assessment of changes in the effectiveness of the hedging relationships concluded by the Bank, make it impossible to present reliable estimates of the potential effects of changes in hedging relationships.

The table presents break down of asstes and liabilities of Santander Bank Polska as at 31 December 2020:

Liquidity risk

Introduction

Liquidity risk is the risk that the bank fails to meet its contingent and non-contingent obligations towards customers and counterparties as a result of a mismatch of financial cash flows.

The activity and strategies on liquidity risk management are directly supervised by the Risk Management Forum and are pursued in accordance with the framework set out in the Liquidity Risk Policy approved by the Management Board and the Supervisory Board.

Risk management structure and organisation

The objective of the Liquidity Risk Policy of Santander Bank Polska is to:

·       ensure the ability to finance assets and satisfy claims, both current and future, in a timely manner and at an economic price;

·       manage the maturity mismatch between assets and liabilities, including the intraday mismatch of cash flows; under normal and stress conditions;

·       set a scale of the liquidity risk in the form of various internal limits;

·       ensure proper organisation of the liquidity management process within the whole Santander Bank Polska;

·       prepare the organisation for emergence of adverse factors, either external or internal;

·       ensure compliance with regulatory requirements, both qualitative and quantitative.

The general principle adopted by Santander Bank Polska in its liquidity management process is that all expected outflows occurring within one month in respect of deposits, current account balances, loan drawdowns, guarantee payments and transaction settlements should be at least fully covered by the anticipated inflows or available High Quality Liquid Assets (HQLA) assuming normal or predictable conditions for the Group’s operations. The HQLA category substantially includes: cash on hand, funds held in the nostro account with the NBP (National Bank of Poland) in excess of the minimum reserve requirement and securities which may be sold or pledged under repo transactions or NBP lombard loans. As at 31 December 2020, the value of the HQLA buffer was PLN 64.76 bn.

The purpose of this policy is also to ensure an adequate structure of funding in relation to the growing scale of the bank’s business by maintaining structural liquidity ratios at pre-defined levels.

The bank uses a suite of additional watch limits and thresholds with respect to the following:

·       loan-to-deposit ratio;

·       ratios of reliance on wholesale funding, which are used to assess the concentration of foreign currency funding from the wholesale market;

·       concentration of deposit and wholesale funding;

·       level of encumbered assets;

·       M3 and M4 regulatory liquidity ratios calculated in accordance with KNF Resolution no. 386/2008;

·       ratios laid down in CRD IV/CRR – LCR and NSFR;

·       survival horizon under stressed conditions;

·       the HQLA buffer;

·       the buffer of assets which might be liquidated over an intraday horizon.

The internal liquidity limits, including the limits established in the Risk Appetite Statement, are set on the basis of both historical values of the selected liquidity ratios as well as their future values which are estimated against a financial plan. The limits also take into account the results of stress tests.

At least once a year, Santander Bank Polska carries out the Internal Liquidity Adequacy Assessment Process (ILAAP), which is designed to ensure that the bank can effectively control and manage liquidity risk. In particular, the ILAAP ensures that the bank:

·       maintains sufficient capacity to meet its obligations as they fall due;

·       reviews the key liquidity risk drivers and ensures that stress testing reflects these drivers and that they are appropriately controlled;

·       provides a record of both the liquidity risk management and governance processes;

·       carries out assessment of counterbalancing capacity.

The ILAAP results are subject to approval by the Management Board and the Supervisory Board to confirm adequacy of the liquidity level of Santander Bank Polska in terms of liquid assets, prudent funding profile and the Group’s liquidity risk management and control mechanisms.

Risk identification and measurement

The responsibility for identification and measurement of liquidity risk rests with the Risk Management Division, specifically the Financial Risk Department.

The role of the Department is to draft liquidity risk management policies, carry out stress tests and to measure and report on risk on an ongoing basis.

Liquidity is measured by means of the modified liquidity gap, which is designed separately for the PLN and currency positions. The reported future contractual cash flows are subject to modifications based on: statistical analyses of the deposit and credit base behaviour and assessment of product/ market liquidity – in the context of evaluation of the possibility to liquidate Treasury securities by selling or pledging them in repo transactions or using liquidity support instruments with NBP, as well as the possibility of transaction rolling in the interbank market.

When measuring liquidity risk, the bank additionally analyses the degree of liquidity outflows arising from potential margin calls due to changes in the value of derivative transactions and collateral needs related to secured financing transactions resulting from the downgrade of the bank’s credit rating, among other things.

Concurrently, liquidity is measured in accordance with KNF Resolution no. 386/2008 on setting liquidity standards for banks (in force as at 31 December 2019), and with the requirements laid down in the CRD IV/ CRR package and in their implementing provisions.

In order to establish a detailed risk profile, the bank conducts stress tests using the six following scenarios:

·       baseline scenario, which assumes non-renewability of wholesale funding;

·       idiosyncratic liquidity crisis scenarios (specific to the bank);

·       local systemic liquidity crisis scenario;

·       global systemic liquidity crisis scenario;

·       combined liquidity crisis scenario (idiosyncratic crisis and local systemic crisis);

·       deposit outflows in a one-month horizon;

·       scenario of accelerated deposit withdrawals via electronic channels.

For each of the above scenarios, the bank estimates the minimum survival horizon. For selected scenarios, the bank sets survival horizon limits which are subsequently included in the liquidity risk appetite.

In addition, the bank performs stress tests for intraday liquidity as well as reverse stress tests.

Risk reporting

The responsibility for reporting liquidity risk rests with the Risk Management Division, specifically the Financial Risk Department.

The results of liquidity risk measurement are reported by the Financial Risk Department on a daily basis to persons in charge of operational management of the bank’s liquidity and to persons responsible for liquidity risk management (information about intraday and current liquidity, including FX funding ratios and LCR) and – on a monthly basis – to senior executives (other liquidity ratios, including regulatory ratios).

Risk prevention and mitigation

The responsibility for supervision over the liquidity risk management process rests with the Assets and Liabilities Committee (ALCO), which also provides advice to the Management Board. ALCO prepares management strategies and recommends to the Management Board appropriate actions with regard to strategic liquidity management, including strategies of funding the bank’s activity. Day-to-day management of liquidity is delegated to the Financial Management Division. The Assets and Liabilities Management Department, which is a part of the Division, is responsible for developing and updating the relevant liquidity management strategies.

The bank has a liquidity contingency plan approved by the Management Board and Supervisory Board to cater for unexpected liquidity problems, whether caused by external or internal factors. The plan, accompanied by stress tests, includes different types of scenarios and enables the bank to take adequate and effective actions in response to unexpected external or internal liquidity pressure through:

·       identification of threats to the bank’s liquidity on the basis of a set of early warning ratios which are subject to ongoing monitoring;

·       effective management of liquidity/ funding, using a set of possible remedial actions and the management structure adjusted to the stressed conditions;

·       communication with customers, key market counterparties, shareholders and regulators.

In 2020, Santander Bank Polska  focused on the effective allocation of the liquidity surplus earned on the inflow of customer deposits in connection with state support programmes related to COVID-19. As at 31 December 2020, the consolidated Liquidity Coverage Ratio was 207%, and 171% as at 31 December 2019. In 2020 and in the comparable period, all key regulatory ratios applicable to the bank and Group were maintained at the required levels.

The tables below show the cumulated liquidity gap on the standalone level (for Santander Bank Polska S.A.) as at 31 December 2020 and in the comparable period (by nominal value).

The tables below show maturity analysis of financial liabilities and receivables on the standalone level (for Santander Bank Polska S.A.) as at 31 December 2020 and in the comparable period (the undiscounted cash flow – capital and interests).

The Bank uses secured instruments to fund its activity to a limited degree only. However, in accordance with the existing contractual provisions, if the Group’s rating is reduced by three notches, the maximum potential additional security on account of those instruments would be PLN 1.47 bn. At the same time, it should be noted that this potential obligation is not unconditional and its final value would depend on negotiations between the bank and its counterparty concerning the transactions.

4.   Capital management

Introduction

It is the policy of Santander Bank Polska to maintain a level of capital adequate to the type and scale of operations and the level of risk.

The level of own funds required to ensure safe operations of the bank and Santander Bank Polska Group and capital requirements estimated for unexpected losses is determined in accordance with:

·       The so-called CRD IV / CRR package, which consists of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (CRR) and Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (CRD IV), which became effective on 1 January 2014 by the decision of the European Parliament and the European Banking Authority (EBA).

·       Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012.

·       Regulation (EU) 2020/873 of the European Parliament and of the Council of 24 June 2020 amending Regulations (EU) No 575/2013 and (EU) 2019/876 as regards certain adjustments in response to the COVID-19 pandemic,

·       These requirements include the recommendations of the KNF regarding the use of national options and higher risk weight for exposures secured by real estate mortgages, including: residential real estate, for which the amount of principal or interest installment depends on changes in exchange rates or currencies other than the currencies of revenue achieved by the debtor, where a risk weight of 150% is assigned, and office premises or other commercial real estate located in the Republic of Poland, where a risk weight of 100% is assigned,  except for exposures secured on commercial real estates which are used by borrower to conduct his own business and do not generate income by rent or proceeds from their sale where a risk weight of 50% is assigned.

·       The Act of 5 August 2015 on macroprudential supervision over the financial system and crisis management in the financial system (“Macroprudential Supervision Act”), implementing CRD IV into the Polish law with regard to, among other things, additional capital buffers to be maintained by banks.

·       Recommendations of the KNF regarding an additional capital requirement relating to the portfolio of FX mortgage loans for households.

The Management Board is accountable for capital management, calculation and maintenance processes, including the assessment of capital adequacy in different economic conditions and the evaluation of stress test results and their impact on internal and regulatory capital and capital ratios. Responsibility for the general oversight of internal capital estimation rests with the Supervisory Board.

The Management Board has delegated ongoing capital management to the Capital Committee which conducts a regular assessment of the capital adequacy of the bank and Santander Bank Polska Group, including in extreme conditions, the monitoring of the actual and required capital levels and the initiation of transactions affecting these levels (e.g. by recommending the value of dividends to be paid). The Capital Committee is the first body that defines the capital policy, principles of capital management and principles of capital adequacy assessment. All decisions regarding any increase or decrease in capital are taken ultimately by relevant authorities within the bank in accordance with the applicable law and the bank’s Statutes.

Pursuant to the bank’s information strategy, details about the level of own funds and capital requirements are presented in the separate report entitled “Information on capital adequacy of Santander Bank Polska Group as at 31 December 2020”.

In 2020, the bank and Santander Bank Polska Group met all regulatory requirements regarding capital management.

Capital Policy

As at 31 December 2019, the minimum capital ratios satisfying the provisions of the CRR and the Macroprudential Supervision Act as well as regulatory recommendations regarding additional own funds requirements under Pillar 2 at the level of Santander Bank Polska S.A. were as follows:

·       Tier 1 capital ratio of 9.25%;

·       total capital ratio of 11.25%;

for Santander Bank Polska Group, those ratios were as follows:

·       Tier 1 capital ratio of  9.276%;

·       total capital ratio of 11.284%.

To mitigate the risk of credit crunch arising from the Covid-19 pandemic, on 18 March 2020 the Minister of Finance, issued a regulation based on the recommendation of the Financial Stability Committee removing banks’ obligation to keep the systemic risk buffer of 3%. The released funds may be used by banks to support their lending activity and cover potential losses in the upcoming quarters.

The aforementioned capital ratios take into account:

·       The minimum capital ratios as required by the CRR: Common Equity Tier 1 ratio at 4.5%, Tier 1 capital ratio at 6.0% and total capital ratio at 8.0%.

·       The KNF’s decision of 5 November 2019, under which the previous recommendations issued on 15 October 2018 and 28 November 2018 regarding an additional capital requirement for Santander Bank Polska S.A. relating to the portfolio of FX mortgage loans for households have expired: the decision followed the process of annual identification of banks with material exposure in respect of FX mortgage-backed loans which concluded that Santander Bank Polska S.A. had not reached the materiality threshold in relation to such loans. Accordingly, the KNF did not impose an additional buffer at the bank level to mitigate the risk arising from mortgage loans for individuals.

·       The capital buffer for Santander Bank Polska S.A. as other systemically important institution: according to the letter of 19 December 2017, the KNF identified Santander Bank Polska S.A. as other systemically important institution and imposed on it an additional capital buffer. Pursuant to the KNF’s decision of 14 October 2019, Santander Bank Polska S.A. maintains additional own funds of 0.75 p.p. Santander Bank Polska Group keeps the capital buffer at the same level.

·       The capital conservation buffer maintained in accordance with the Macroprudential Supervision Act: following adaptation to the CRR requirements, in 2019 the buffer reached the maximum level of 2.50 p.p.

·       The countercyclical buffer implemented by the Macroprudential Supervision Act and amended by the Minister of Finance by a way of regulation: since 1 January 2016, the countercyclical buffer has been set at 0 p.p. for credit exposures in Poland..

·       The additional capital requirement was set at the level of Santander Bank Polska Group in accordance with the KNF’s decision of 11 December 2020. As at 31 December 2020, the buffer related to the portfolio of FX mortgage loans for households was 0.034 p.p for the total capital ratio, 0.026 p.p. for the Tier 1 capital ratio and 0.019 p.p. for the Common Equity Tier 1 ratio

Regulatory Capital

The capital requirement for Santander Bank Polska is determined in accordance with Part 3 of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (CRR), as amended, inter alia, by Regulation (EU) 2020/873 of the European Parliament and of the Council of 24 June 2020 amending Regulations (EU) No 575/2013 and (EU) 2019/876 as regards certain adjustments in response to the COVID-19 pandemic, which was the official legal basis as at the reporting date, i.e. 31 December 2020.

Santander Bank Polska uses the standardised approach to calculate the capital requirement for credit risk, market risk and operational risk. According to this approach, the total capital requirement for credit risk is calculated as the sum of risk-weighted exposures multiplied by 8%. The exposure value for these assets is equal to the carrying amount, while the value

of off-balance sheet liabilities corresponds to their balance sheet equivalent. Risk-weighted exposures are calculated by means of applying risk weights to all exposures in accordance with the CRR.

Potential impact of the New Default Definition

Estimated impact on the Bank’s capital ratios: CAR down 2 bp to 23.32%, CET1 down 2 bp to 20.92%, RWA up PLN 80m.

Estimated impact on the capital ratios of Santander Bank Polska Group: CAR down 3 bp to 20.02%, CET1 down 3 bp to 17.99%, RWA up PLN 158m.

The table below presents the calculation of the capital ratio for Santander Bank Polska SA as at 31 December 2020 and in the comparative period.

* Pursuant to the KNF’s decision of 11 October 2019, the bank received consent to allocate PLN 589,819,448 of Santander Bank Polska net profit for H1 2019 to the Common Equity Tier 1 capital.

* Pursuant to the KNF’s decision of 30 December 2020, the bank received consent to allocate PLN 192,430,453 of Santander Bank Polska net profit for H1 2020 to the Common Equity Tier 1 capital.

Internal Capital

Notwithstanding the regulatory methods for measuring capital requirements, Santander Bank Polska S.A. carries out an independent assessment of current and future capital adequacy as part of the internal capital adequacy assessment process (ICAAP). The purpose of the process is to ensure that the level and nature of own funds guarantee the solvency and stability of the bank’s and the Group’s operations.

The capital adequacy assessment is one of the fundamental elements of the bank’s strategy, the process of defining risk appetite and the process of planning.

In the ICAAP the Bank uses assessment models based on the statistical loss estimation for measurable risks, such as credit risk, market risk and operational risk, plus its own assessment of capital requirements for other material risks not covered by the model, e.g. reputational risk and compliance risk.

The internal capital is estimated on the basis of risk parameters including the probability of default (PD) by Santander Bank Polska S.A. customers and the loss given default (LGD).

The Group performs an internal assessment of capital requirements, including under stressed conditions, taking into account different macroeconomic scenarios.

Internal capital estimation models are assessed and reviewed annually to adjust them to the scale and profile of the business of Santander Bank Polska S.A. and to take account of any new risks and the management’s judgement.

The review and assessment is the responsibility of the bank’s risk management committees, including: the Capital Committee and the Models and Methodology Panel, which is part of the Risk Management Forum.

Subordinated Liabilities

In 2016, the bank amended the agreement under which subordinated registered bonds were issued on 5 August 2010 and taken up by the European Bank for Reconstruction and Development. Under the new issue conditions, the maturity of the bonds has been extended to 5 August 2025. Pursuant to the KNF’s decision of 18 May 2017, the bank was authorised to allocate EUR 100m of the new issue to Tier 2 capital. Since 5 August 2020, it is subject to amortization due to the final 5 years of the loan maturity according to Art. 64 CRR.

As part of the strategy to increase the Tier 2 capital, on 2 December 2016 Santander Bank Polska issued own bonds of EUR 120m, allocating them to Tier 2 in accordance with the KNF’s decision of 24 February 2017.

On 22 May 2017, the bank issued additional subordinated bonds with a nominal value of EUR 137.1m and by the KNF’s decision of 19 October 2017 was authorised to allocate them to the Tier 2 capital.

On 12 June 2018, Santander Bank Polska S.A. obtained the KNF’s approval for allocating series F subordinated bonds with a total nominal value of PLN 1bn, issued on 5 April 2018, to Tier 2 capital instruments.

For more information on subordinated liabilities, see Note 34.

5.   Net interest income

*Details on the impact of the CJEU judgment in case C 383/18 on interest income are presented in note 46

6.   Net fee and commission income

Included above is fee and commission income on credits, credit cards, off-balance sheet guarantees and leases of PLN 491,285 k (31.12.2019: PLN 506,964 k) and fee and commission expenses on credit cards, leases and paid to credit agents of PLN (45,312) k (31.12.2019: PLN (49,537) k) other than fees included in determining the effective interest rate, relating to financial assets and liabilities not carried at fair value through profit and loss.

7.   Dividend income

8.   Net trading income and revaluation

The amounts included CVA and DVA adjustments which in 2020 and 2019 totaled PLN (5,240) k and PLN (3,227) k respectively.

9.   Gains (losses) from other financial securities

10. Other operating income

* Pursuant to Article 393(3) of the Commercial Companies Code and § 24(1) of the Bank’s Statutes, the Extraordinary General Meeting of Shareholders of Santander Bank Polska  held on 23 September 2019 approved the sale of an organised part of the bank’s enterprise, namely the Investment Services Centre, which is a separate organisational unit representing an organisationally, financially and functionally independent set of tangible and intangible assets.

The Centre provides professional transfer agent services for Santander Towarzystwo Funduszy Inwestycyjnych  and investment funds managed by that company.

The agreement also provides for the subsequent sale of an organised part of the enterprise of Santander Towarzystwo Funduszy Inwestycyjnych  (a subsidiary of Santander Bank Polska ), namely the Valuations and Reporting Department, which is a separate organisational unit responsible for settlements, valuations and reporting of investment funds.

11.Impairment losses on loans and advances

Management adjustment in the level of allowances reflecting the risk related to the COVID-19 situation amounted to PLN 80.300 k as at 31.12.2020 – details are described in Note 2.6

12.Employee costs

* On 29.10.2020 The Management Board of Santander Bank Polska S.A. advises that, as per the Act of 13 March 2003 on special rules of terminating employment contracts for reasons not attributable to the employees, they adopted a resolution on the start of collective redundancies procedure in Santander Bank Polska S.A.

It is the intention of the Bank's Management Board to carry out the process of collective redundancies until 31.12.2022 in relation to no more than 2,000 people, which represents approx. 18.52% of all employees of the Bank as of 30.09.2020. The process is spread over more than two years due to extraordinary market conditions related to the pandemic.

A provision of PLN (121,000) k was raised in Santander Bank Polska S.A. books in relation to employment restructuring.

* On 10.01.2019 The Management Board of Santander Bank Polska SA informed that, as per the Act of 13 March 2003 on special rules of terminating employment contracts for reasons not attributable to the employees, they adopted a resolution on the intended collective redundancies and the start of the consultation procedure for collective redundancies.

A provision of PLN (92,400) k was raised in Santander Bank Polska S.A. books in relation to employment restructuring in 2019.  Details on charge and utilization of restructuring provision are disclosed in Note 37.

13.General and administrative expenses

14.Other operating expenses

* Details in note 37

15.Corporate income tax

16.Earnings per share

The weighted average number of ordinary shares contains dilutive instruments in the form of share capital presented in note 39 and the share based incentive scheme included in note 53.

17.Cash and balances with central banks

Santander Bank Polska SA hold an obligatory reserve in a current account in the National Bank of Poland. The figure is calculated at a fixed percentage of minimal statutory reserve of the monthly average balance of the customers’ deposits, which until 29 April 2020 was 3.5%.

Pursuant to Resolution no. 2/2020 of 17 March 2020 the minimum reserve requirement has been reduced to 0.5% and applies from 30 April 2020.

In accordance with the applicable regulations, the amount of the calculated provision is reduced by the equivalent of EUR 500 k

18.Loans and advances to banks

Fair value of loans and advances to banks is presented in Note 45.

19.Financial assets and liabilities held for trading

Financial assets and liabilities held for trading - trading derivatives include the change in the value of counterparty risk in the amount of PLN (10,763) k as at 31.12.2020 and PLN (3,979) k as at 31.12.2019.

Interest income from debt instruments and other fixed rate instruments is disclosed under interest income.

Profit and loss from fair value changes of financial assets and liabilities held for trading are disclosed under net trading income and revaluation in the income statement.

All financial assets measured at fair value through profit and loss are assigned to this category due to the trading character of the transactions. At 31.12.2020 and in comparable period there were no cases of instruments designated to financial assets measured at fair value through profit and loss at initial recognition.

The table below presents derivatives’ nominal values:

In the case of single-currency transactions (IRS, FRA, non-FX options) only purchased amounts are presented.

20.Hedging derivatives

As at 31.12.2020 in the line item Hedging derivatives - derivatives hedging cash flow include value adjustments day first profit or loss for start forward CIRS transactions in the amount of PLN (6,456) k and PLN (7,510) k as at 31.12.2019.

21.Loans and advances to customers

As at 31.12.2020 the fair value adjustment due to hedged risk on loans was PLN (9,601) k.

The gross carrying amount of a financial asset is the amortised cost of the asset before adjustment by any allowances for expected credit losses, excluding calculated penalty interest on overdue principal. Recognition of a full value of the calculated penalty interest on overdue principal would result in an increase in the gross carrying amount of loans and advances to customers, while causing the value of allowances for expected credit losses to increase by PLN 689, 367 as at 31.12.2020 and as at 31.12.2019 by PLN 819,131 k.

Fair value of loans and advances to customers is presented in Note 45.