FINANCIAL INSTRUMENTS Fair value determination

The fair value of a financial instrument is determined using either prices quoted in an active market or the Company's own valuation techniques where no active market exists. The valuation tech-niques used include the discounted cash flow method, net present value techtech-niques and a com-parison with similar instruments quoted in an active market. The valuation techniques take account of estimated credit risk, applicable discount rates, the possibility of premature repayment and other factors affecting the reliable measurement of the fair value of financial instruments.

Offsetting financial assets and liabilities

Financial assets and liabilities are offset and the net amount reported in the balance sheet only if there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis. Pohjola Bank plc did not apply the off-set procedure during the financial year.

Securities sale and repurchase agreements

The purchase price of securities bought under 'resell conditions' binding on both parties is recog-nised as a receivable under the balance sheet item determined by the counterparty. The difference between the purchase price and resale price is treated as interest income and accrued over the term of the agreement.

The selling price of securities sold under 'resell conditions' binding on both parties is recognised as a financial liability under the balance sheet item determined by the counterparty. The difference between the selling price and the repurchase price is treated as interest expenses and accrued over the term of the agreement. Securities sold under the repurchase obligation and the corre-sponding securities provided as maintenance margin are included in the original balance sheet item despite the disposal.

Classification and recognition

On the basis of their initial recognition, financial assets and liabilities are classified as financial assets at fair value through profit or loss, loans and other receivables, held-to-maturity invest-ments, available-for-sale financial assets, financial liabilities at fair value through profit or loss and other financial liabilities, in accordance with their measurement practice. Financial assets at fair value through profit or loss are subdivided into financial assets held for trading and financial assets at fair value through profit or loss at inception. Financial liabilities at fair value through profit or loss are financial assets held for trading.

The purchase and sale of financial assets and liabilities at fair value through profit or loss, held-to-maturity investments and available-for-sale financial assets are recognised in the balance sheet on the transaction date, or the date on which the Company agrees to buy or sell the asset or liability in question. Notes and bonds classified as loans and other receivables are recognised as financial assets on the transaction date and loans granted on the date on which the customer draws down the loan.

Financial assets are derecognised when the contractual right to receive cash flows from the finan-cial asset has expired or the Group has transferred all risks and rewards of ownership. Finanfinan-cial liabilities are derecognised when they are extinguished, i.e. when the obligation is discharged, cancels or expires.

Financial assets and liabilities held for trading

All financial assets and liabilities which are expected to generate short-term profits arising from fluctuations in interest rates, prices and quotations or in which an embedded derivative contract cannot be separated from the host contract, are classified as held for trading. Financial assets and liabilities held for trading include financial derivatives other than those used for hedging purposes.

Financial assets and liabilities held for trading are recognised at fair value in the balance sheet, and subsequent changes in the fair value are recognised under 'Net income from securities trad-ing' in the income statement.

Financial assets at fair value through profit or loss at inception

In accordance with Pohjola Group's risk management principles, Pohjola Bank plc manages in-vestments and assesses their performance at fair value in order to receive a true and real-time picture of investment operations. Reporting to the Group's management is based on fair values.

Financial assets irrevocably recognised at fair value through profit or loss at inception comprise bonds used in the management of liquidity. Since the business involves investment on a longer-term basis, financial assets are presented separately from those held for trading. In addition, this asset class includes hybrid instruments in which the fair value of an embedded derivative cannot be determined separately. These financial assets are measured at fair value in the balance sheet, and any subsequent changes in the fair value are recognised under 'Net income from securities trading' in the income statement.

Loans and other receivables

Financial assets classified as loans and receivables are non-derivative financial assets with fixed or determinable payments that have been created by lending money or rendering services. Not quoted in an active market, loans and other receivables are carried at cost. Financial assets cate-gorised into this item are recognised in the balance sheet item determined by the counterparty, either under 'Receivables from credit institutions' or 'Receivables from the public and public sector entities'.

Impairments are recognised and impairment losses incurred only if there is objective evidence of a debtor's reduced solvency after the initial recognition of the receivable. A receivable is impaired if the present value of estimated future cash flows – including the fair value of collateral – is lower than the aggregate carrying amount of the loan and the related unpaid interest. Estimated future cash flows are discounted at the loan's original interest rate. If the loan carries a variable interest rate, the discount rate for measuring any impairment is the current effective interest rate deter-mined under the agreement. The difference between the carrying amount of the loan and a lower recoverable amount is recognised as an impairment charge in the income statement.

Impairments of loans and other receivables are recognised on an individual or collective basis.

Impairments will be assessed and recognised on an individual basis if the debtor's total exposure is significant. In the case of minor customer exposure, impairments are assessed and recognised on a collective basis. Indemnity received due to impairments is recognised as an adjustment for impairment losses. Recognition of interest on the reduced amount continues after the recognition of impairment. For notes and bonds classified as loans and other receivables, the difference be-tween the carrying amount of the note/bond and a lower recoverable amount is recognised as an impairment loss in the income statement. Impairments are recognised as an allowance of loans in

the balance sheet and as 'Impairment losses on loans and other commitments' in the income statement.

Impairment loss is recognised for a group of receivables if there is objective evidence that debtors' ability to pay amounts due is uncertain. The amount recognised as an impairment loss is based on experience of the extent to which payment defaults lead to credit losses and of the amount to which the realisation of collateral will cover the incurred loss.

After the completion of all debt-collection measures, or otherwise based on the management's decision, the loan is derecognised. Following the derecognition, payments received are recognised as an adjustment to impairments of receivables.

If there is subsequent objective evidence of the improved solvency of the creditor previously in-cluded in impairment testing, the amount of the impairment loss will be reassessed and any change in the recoverable amount will be recorded in the income statement.

Interest on a non-performing receivable will be recognised as revenue if the receivable has be-come non-performing one on 1 January 2005 or thereafter. Non-performing receivables refer to receivables whose interest, principal or part thereof has been due for payment and outstanding for three months. Receivables from a company declared bankrupt is recorded as non-performing ones no later than the date when the company was declared bankrupt. Receivables based on guarantee given are recorded as non-performing ones when payment based on the guarantee is settled.

Investments held to maturity

Investments held to maturity are non-derivative financial assets with fixed or determinable pay-ments that the company has the positive intention and ability to hold to maturity. These invest-ments are carried at amortised cost after their initial recognition using the effective interest method. The difference between the nominal value and the acquisition value of bonds is allocated over the residual term to maturity.

If investments included in the financial assets held to maturity category are sold before their matur-ity, all of these investments must be reclassified out of this category into the available-for-sale financial assets category, and the Group may not classify these securities into the financial assets held to maturity category for the subsequent two years.

Impairments of investments held to maturity are reviewed on the basis of the same principles as those of loans and other receivables. The difference between the carrying amount of an invest-ment and a lower recoverable amount is recognised as an impairinvest-ment loss in the income state-ment.

Available-for-sale financial assets

Available-for-sale financial assets include non-derivative financial assets which have been directly categorised as available for sale or which are not classified as the abovementioned financial as-sets, consisting mainly of notes and bonds, long-term equity investments and other shares and participations necessary for operations.

Available-for-sale financial assets are recognised at cost at the time of acquisition and measured at fair value. If the fair value cannot be determined reliably, shares and participations necessary for operations and other unquoted shares and participations are measured at cost. Any changes in their fair value are recognised in the 'Fair value reserve' under shareholders' equity, from where they, including any capital gain or loss, are transferred to 'Net income from available-for-sale fi-nancial assets' in the income statement when the asset is derecognised or impaired. Interest in-come and dividends are recorded in the inin-come statement.

The company monitors impairments of available-for-sale financial assets in accordance with its risk management principles. If there is objective evidence of an impaired investment, the differ-ence between the purchase cost and the fair value on the review date, less impairments losses previously recognised on the asset in question included in the financial asset, will be recognised in the income statement. If the fair value of impaired notes and bonds classified as available-for-sale financial assets increases subsequently and this increase can be objectively regarded as being

related to an event after their impairment loss recognition, the impairment loss will be reversed and recorded in the income statement. If the fair value of an impaired share increases subsequently, this increase will be recognised in shareholders' equity.

The difference between the nominal value and the acquisition cost of fixed-rate bonds is allocated over the residual term to maturity, using the effective interest method.

Shares and holdings in affiliates and Group companies

Shares and holdings and other equity investments in affiliates and Group companies are recog-nised at cost or, if the item's value on the balance sheet date is found to be lower than the acquisi-tion cost due to impairment, at cost less impairment losses. Impairments are recognised under 'Impairment losses on other financial assets' in the income statement.

Cash and cash equivalents

Cash and cash equivalents consist of cash and receivables from credit institutions repayable on demand.

Other assets

Other assets comprise receivables repayable on demand arising from brokerage, receivables in various clearing accounts, marginal account receivables related to derivative contracts and all other receivables which cannot be presented under any other suitable balance sheet item, such as various accounts receivable, rental receivables and insurance claim receivables.

Other financial liabilities

Other financial liabilities include financial liabilities other than those held for trading.

After initial recognition, they are carried at cost. The difference between the nominal value and the acquisition cost of fixed-rate bonds is allocated over the residual term to maturity, using the effec-tive interest method. The countervalue is recognised as an increase or decrease in the liability's book value.

Other liabilities

Other liabilities consist mainly of payment transfer liabilities, accounts payable and liabilities re-lated to securities trading.

Derivative contracts

A derivative instrument represents a financial instrument or another instrument whose value changes as a result of changes in specific interest rates, the price of financial instruments or com-modities, foreign exchange rates, price or interest-rate indices, credit ratings, credit indices or other similar underlying instruments. At the time of entering into the contract, a derivative requires only minor initial net investment and will be settled on a predetermined future date.

Derivatives are divided into hedging and non-hedging contracts. Both hedging and non-hedging derivatives are recognised at fair value in the balance sheet. Accrued interest on non-hedging interest rate swaps is recognised in interest income and interest carried forward corresponding to them in deferred income and deferred expenses. Changes in the fair value of non-hedging inter-est-rate, loan, currency, equity and commodity derivatives are recognised under 'Net income from foreign exchange trading' in the income statement. Positive fair value changes and premiums paid for derivative contracts are recognised as assets under 'Derivative contracts' while negative fair value changes and premiums received from derivative contracts are recognised under 'Derivative contracts and other liabilities held for trading'.

Embedded derivatives associated with structured bonds issued and housing loans with an interest-rate cap are sepainterest-rated from the host contract and measured at fair value, and changes in the fair value of these embedded derivatives and derivatives designated as hedging instruments are rec-ognised in interest income or expenses.