6. Interest income and expenses

Interest income and expense is recognized on an accruals basis using the effective interest rate which discounts the estimated future cash flows throughout the life of the financial asset or financial liability to the carrying amount in respect of assets and to amortized cost in respect of financial liabilities, with the following exception:

• purchased or originated assets impaired due to credit risk (POCI). Interest income on POCI assets is calculated on the net carrying amount using the effective interest rate adjusted by credit risk recognized over the life cycle of the asset; ,
• financial assets which were not POCI assets, impaired due to credit risk, which then became credit impaired financial assets. Interest income on POCI assets is calculated on the net carrying amount using the original effective interest rate from the moment of recognizing premises for impairment of the asset.

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

The effect of the fair value measurement of financial assets acquired as part of business combinations between subsidiaries and impact of the European Union Court of Justice’s ruling on consumer rights to reduce the cost of loan repaid before contractual maturity were also recognized in interest income.

Due to the fact that the Group offers insurance products along with loans, advances and lease products and there is no possibility of purchasing an insurance product from the Group that is identical as to the legal form, conditions and economic content without purchasing a loan, an advance or a lease product, the payments received by the Group for the insurance products sold are treated as an integral part of the remuneration for the financial instruments offered.

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

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

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

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

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

The Group makes periodical estimations of the remuneration amount that will be recoverable in the future due to the early termination of the insurance contract based on historical data on premiums collected and refunds made. The provision for future refunds is allocated to the financial instrument and insurance service in accordance with the relative fair value model.

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

In 2019, the Group reduced interest income on loans and advances to customers by PLN 178 million (the amount of PLN 31 relates to paid automatically before the balance sheet date reimbursement of costs and the amount of PLN 147 million relates to provisions for future reimbursement of costs) due to the European Union Court of Justice’s ruling on consumer rights to reduce the cost of loan repaid before contractual maturity.