11.5 The principles for classification of financial instruments

The Group classifies financial assets into the following categories:

• measured at amortized cost;
• measured at fair value through other comprehensive income;,
• measured at fair value through profit or loss.

The Group classifies financial liabilities into the following categories:

• measured at amortized cost;
• measured at fair value through profit or loss.

Classification of financial assets as at the date of acquisition or origination depends on the business model adopted by the Group for the purposes of managing a particular group of assets and on the characteristics of the contractual cash flows resulting from a single asset or a group of assets. The Group identifies the following business models:

• the “held to collect” cash flows model, in which financial assets originated or acquired are held in order to collect gains from contractual cash flows – this model is typical of lending activities;
• the “hold to collect and sell” cash flows model, in which financial assets originated or acquired are held to collect gains from contractual cash flows, but they may also be sold (frequently and in transactions of a high volume) – this model is typical of liquidity management activities;
• the residual model – other than the “held to collect” or the “hold to collect and sell” cash flows model.

The business model is determined/selected upon initial recognition of financial assets. The determination/selection is performed at the level of individual groups of assets, in the context of the business area in connection with which the financial assets originated or were acquired, and is based, among other things, on the following factors:

• the method for assessing and reporting the financial assets portfolio;
• the method for managing the risk associated with such assets and the principles of remunerating the persons managing such portfolios.

In the “hold to collect” business model, assets are sold occasionally, in the event of an increase in credit risk or a change in the laws or regulations. The purpose of selling the assets is to maintain the assumed level of regulatory capital. Assets are sold in accordance with the principles described in the portfolio management strategy or close to maturity, in the event of a decrease in the credit rating below the level assumed for a given portfolio, significant internal restructuring or acquisition of another business, the performance of a contingency or recovery plan or another unforeseeable factor independent of the Group.

The assessment of the contractual cash flow characteristics establishes, based on a test of contractual cash flows, whether contractual cash flows are solely payments of principal and interest (hereinafter “SPPI test”). Interest is defined as consideration for the time value of money, credit risk relating to the principal remaining to be repaid within a specified period and other essential risks and costs associated with granting financing, as well as the profit margin.

Contractual cash flow characteristics do not affect the classification of the financial asset if:

• their effect on the contractual cash flows from that asset could not be significant (de minimis characteristic);
• they are not genuine, i.e. they affect the contractual cash flows from the instrument only in the case of occurrence of a very rare, unusual or very unlikely event (non-genuine characteristic).

In order to make such a determination, the Group takes onto account the potential impact of the contractual cash flow characteristics in each reporting period and throughout the whole life of the financial instrument is considered.

The SPPI test is performed for each financial asset in the “hold to collect” or “hold to collect and sell” models upon initial recognition (and for modifications which are significant after subsequent recognition of a financial asset).

The Group analyses, among others, the following features of financial assets which result in the SPPI test being failed:

• leverage in the design of interest rate, understood as a multiplier higher than 1;
• a creditor’s right to participate in the profit – contractual cash flows are not only the repayment of principal and interest on the outstanding principal;
• limitation of the debtor’s liabilities (resulting in a non-recourse asset);
• early repayment and extension option contingent on a future economic event which does not relate to the agreement, particularly an event not related to a change in the borrower’s credit risk level;
• covenants providing for an increase or decrease in interest rate in line with an increase or decrease in credit risk, which reflects a negative relation between the loan margin and the level of credit risk;
• interest rates unilaterally determined by the Group (administered interest rates), if they do not approximate variable market rates.

If the qualitative assessment performed as part of the SPPI test is insufficient to determine whether the contractual cash flows are solely payments of principal and interest, a benchmark test (quantitative assessment) is performed to determine the difference between the (non-discounted) contractual cash flows and the (non-discounted) cash flows that would occur should the time value of money remain unchanged (the reference level of cash flows).