Annex

Basis of preparation of the consolidated financial statements

The consolidated financial statements of the Volksbanken Raiffeisenbanken Cooperative Financial Network for the period from January 1 to December 31, 2017, prepared by the Bundesverband der Deutschen Volksbanken und Raiffeisenbanken e.V. (BVR), have to be prepared for a specific purpose pursuant to the financial reporting principles set out below. They have been prepared for informational purposes and to present the business development and performance of the Cooperative Financial Network, which is treated as a single economic entity in terms of its risks and strategies. In addition, the financial statements were prepared in compliance with the provisions set out in article 113(7)(e) of Regulation (EU) No. 575/2013 of the European Parliament and of the Council of June 26, 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No. 648/2012 (Capital Requirements Regulation – CRR).

The consolidated financial statements have to include the following components:

• Income statement for the period from January 1 to December 31, 2017 (pursuant to IAS 1.81 A to IAS 1.105)
• Statement of comprehensive income for the period from January 1 to December 31, 2017 (pursuant to IAS 1.81A to IAS 1.105)
• Balance sheet as at December 31, 2017 (pursuant to IAS 1.54 to IAS 1.80A)
• Statement of changes in equity for the period from January 1 to December 31, 2017 (pursuant to IAS 1.106 to IAS 1.110) Statement of cash flows
• Statement of cash flows for the period from January 1 to December 31, 2017 (pursuant to IAS 7.1 to IAS 7.47)
• Explanatory information on the consolidated financial statements
• Management report including risk report for the period from January 1 to December 31, 2017

The consolidated financial statements have to include comparative figures for the prior year. The consolidated financial statements have to be prepared in euros. Unless stated otherwise, all amounts have to be shown in millions of euros (€ million). All figures have to be rounded to the nearest whole number.

Financial instruments

Financial instruments have to be designated upon initial recognition to the categories set out below if their characteristics and intended use meet the criteria for the relevant category. The following categories have been defined:

Financial instruments at fair value through profit or loss

Financial instruments in this category have to be recognized at fair value through profit or loss. This category has to be broken down into the following subcategories:

Financial instruments held for trading
Financial assets and financial liabilities that are acquired or incurred for the purpose of selling or repurchasing them in the near term, that are 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 profittaking, or that are derivatives, except for derivatives that are designated and effective hedging instruments have to be assigned to the ‘financial instruments held for trading’ subcategory.

Contingent consideration in a business combination
Contingent considerations that the acquirer has classified as financial assets or financial liabilities in the context of a business combination have to be assigned to this subcategory.

Financial instruments designated as at fair value through profit or loss; fair value option
Financial assets and financial liabilities may be designated to the ‘financial instruments designated as at fair value through profit or loss’ subcategory by exercising the fair value option, provided that the application of this option eliminates or significantly reduces measurement or recognition inconsistencies (accounting mismatches), the financial assets and liabilities are managed as a portfolio on a fair value basis or they include one or more embedded derivatives required to be separated from the host contract.

Held-to-maturity investments

Non-derivative financial assets with fixed or determinable payments and fixed maturity that an entity has the positive intention and ability to hold to maturity can be assigned to the ‘held-to-maturity investments’ category. These assets have to be measured at amortized cost. The premiums and discounts have to be allocated over the expected life of the instrument.

Liabilities from capitalization transactions that are not designated as unit-linked insurance products also have to be assigned to this category. There is no significant transfer of insurance risk in these transactions and they do not therefore satisfy the criteria for an insurance contract under IFRS 4, appendix A. As a consequence, such transactions need to be treated as financial instruments in accordance with the principles defined above.

Other financial instruments

Insurance-related financial assets and financial liabilities, receivables and liabilities arising from finance leases, and liabilities from financial guarantee contracts have to be categorized as other financial instruments.

Insurance-related financial assets and financial liabilities as well as receivables and liabilities from finance leases have to be recognized and measured in accordance with the principles set out in this section and in the corresponding sections entitled ‘Insurance business’ and ‘Leases’.

Liabilities from financial guarantee contracts must be recognized as a liability at fair value by the issuer of the guarantee at the date of issue. The fair value normally has to be equivalent to the present value of the consideration received for issuing the financial guarantee contract. In any subsequent measurement, the obligation must be measured at the higher of the provision amount determined and the amount initially recognized less any cumulative amortization.

Application of the fair value option

In the consolidated financial statements, the fair value option has to be applied in all scenarios set out in IAS 39.9. The fair value option has to be applied to eliminate or significantly reduce accounting mismatches that arise if non-derivative financial instruments and related derivatives used to hedge such instruments are measured differently. Derivatives have to be measured at fair value through profit or loss, whereas non-derivative financial instruments generally have to be measured at amortized cost or changes in fair value have to be recognized in other comprehensive income. If the relevant hedge accounting criteria are not met, this gives rise to accounting mismatches that can be significantly

In the case of debt instruments, important objective evidence of impairment includes financial difficulties on the part of the issuer or debtor, delay or default on interest payments or repayments of principal, failure to comply with ancillary contractually agreed arrangements or the contractually agreed provision of collateral, a significant downgrading in credit rating or issue of a default rating. In the case of securitization exposures, impairment testing requires an assessment of the assets underlying the securitization.

Significant objective evidence of impairment in the case of equity instruments includes a lasting deterioration in financial performance, sustained losses or consumption of equity, substantial changes with adverse consequences for the issuer’s technological, market, economic or legal environment, and/or a considerable or enduring reduction in fair value associated with such changes.

There are indications that financial assets may be impaired if the fair value falls by more than 20 percent of average cost or if the fair value remains below average cost for more than six months.

As regards securities, the disappearance of an active market for a financial asset owing to financial difficulties on the part of the issuer may constitute evidence of impairment.

Embedded derivatives

Embedded derivatives that are combined with a non-derivative financial instrument (host contract) in a hybrid (compound) instrument must be separated from the host contract and accounted for separately if the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the hybrid (compound) instrument is not measured at fair value through profit or loss. If these conditions are not met, the embedded derivative may not be separated from the host contract. If an embedded derivative has to be separated, the individual components of the compound instrument have to be recognized and measured in accordance with the rules for the original financial instruments.

Hedge accounting

Fair value hedges

A fair value hedge is intended to ensure that changes in the fair value of the hedged item are offset by countervailing changes in the fair value of the hedging instrument. Changes in the fair value of the hedged item attributable to the hedged risk and changes in the fair value of the hedging instrument have to be recognized in profit or loss. Risks have to be hedged by designating hedges either on an individual or on a portfolio basis.

If the functional currency of entities consolidated in the financial statements is different from the reporting currency (euros), all assets and liabilities have to be translated at the closing rate. Equity has to be translated at the historical rate, while income and expenses have to be translated at average rates. Any differences arising from currency translation have to be reported in the currency translation reserve.

Insurance business

General information on the accounting treatment of insurance business

Insurance contracts have to be recognized in accordance with the requirements of IFRS 4.13–35. Capitalization transactions have to be classified as financial instruments and recognized in accordance with the aforementioned principles. Service contracts are subject to the revenue recognition requirements specified in IAS 18.20–28.

The insurance business of the Cooperative Financial Network has to be generally reported under specific insurance items in the income statement and on the balance sheet.

Financial assets and financial liabilities

Financial assets and financial liabilities held or acquired as part of insurance business have to be accounted for in accordance with the accounting principles for financial instruments presented above. These financial assets and financial liabilities have to be reported under investments held by insurance companies, other assets held by insurance companies, and other liabilities of insurance companies. Any impairment losses related to financial assets reported under investments held by insurance companies or other assets held by insurance companies are applied directly to the carrying amount.

The benefit obligations under capitalization transactions for which no material insurance risk is assumed when the policy is concluded have to be included in other liabilities of insurance companies. They have to be reported under liabilities from capitalization transactions. The underlying financial instruments in these transactions have to be reported as part of assets related to unit-linked contracts under investments held by insurance companies.

Provision for unearned premiums
The provision for unearned premiums has to cover premiums that have already been collected but that relate to future periods.

The provision for unearned premiums from direct non-life insurance operations has to be calculated from the gross premiums using the 360-day system. Calculation of non-transferable income components has to be based on the letter from the Bundesministerium der Finanzen (BMF) [German Federal Ministry of Finance] dated April 30, 1974.

Unearned premiums from life insurance have to be calculated taking into account the starting date and maturity date of each individual policy after deduction of non-transferable premium components.

The proportion of the provision for unearned premiums relating to ceded insurance business has to be calculated as specified in the individual reinsurance contracts.

Benefit reserve
The purpose of the benefit reserve is to ensure that guaranteed entitlements to future insurance benefits can be satisfied on a permanent basis. Guaranteed entitlements for insured persons in respect of life insurance and casualty insurance with premium refund as well as the provision for increasing age in health insurance have to be reported under the benefit reserve.

The benefit reserve for life insurance and casualty insurance with premium refund generally has to be calculated on the basis of individual policies taking into account starting dates in accordance with approved business plans and the principles declared to the relevant regulatory authorities. The prospective method has to be used for life insurance (except for unit-linked insurance products and account management arrangements) and for casualty insurance (with the exception of premium-based policies that started prior to 1982). The retrospective method has to be used for other types of insurance. Negative benefit reserves on an individual policy basis have to be recognized with an amount of zero.

The assumptions used in calculations are determined in accordance with current recommendations issued by the Deutsche Aktuarvereinigung e.V., Cologne, (DAV) [German Actuarial Association] and the regulator and in accordance with other national statutory provisions and regulations. These interest rates are generally determined by the legally prescribed maximum discount rates. The calculation assumptions apply from the date on which the policy is written until the policy expires.

Provision for claims outstanding
The provision for claims outstanding has to cover benefit obligations arising from claims in which it is not yet possible to reliably determine the amount and/or the timing of the payment. The provision has to be recognized for claims that have already been reported and also for insured events that have occurred but have not yet been reported. It has to include both internal and external expenses as well as the cost of settling claims.

The provision for claims outstanding in direct nonlife insurance business has to be determined on a case-by-case basis for known claims. Recourse claims, excess proceeds, and claims under loss sharing agreements have to be netted. Based on the level of delayed claims reports observed in previous years, an additional claims provision has to be recognized for claims that occur or are caused before the balance sheet date but have not yet been reported by this date. Statistical estimates have to be used in this measurement. The provision for claims outstanding does not have to be discounted, except in the case of the pension benefits reserve. The provisions for claims settlement expenses, which are also included in this item, have to be calculated in accordance with the requirements set out in the coordinated regulations issued by the German federal states on February 2, 1973 and in accordance with formula 48 (German Insurance Association [GDV] formula) as specified in a letter dated March 20, 1973. Under these arrangements, internal costs likely to be incurred in connection with the settlement of future claims have to be projected using an overall rate applied to the present level of expenses.

The provision for claims outstanding as regards life insurance and pension funds has to be determined on a case-by-case basis. The provision has to be recognized for claims that have already been incurred and reported by the balance sheet date, but have not yet been settled.

A provision for settlement expenses has to be recognized in an amount equivalent to 1 percent of the claims provision to cover claims incurred and reported by the balance sheet date (excluding maturing policies) and also IBNR losses.

Within the overall provision for premium refunds, a distinction has to be made between provisions attributable to bonuses already declared but not yet allocated (including participation in valuation reserves in accordance with HGB), the funding used to finance future terminal bonuses, and the free provision for premium refunds. Expenses for deferred premium refunds have to be recognized in an amount equivalent to 90 percent of the difference between the carrying amounts for items in the financial statements prepared in accordance with these significant financial reporting principles and those in the financial statements prepared in accordance with HGB net of deferred taxes.

The provision for premium refunds related to health insurance has to include amounts allocated to policyholders under statutory or contractual arrangements for bonuses and rebates. Expenses for deferred premium refunds have to be recognized in an amount equivalent to 80 percent of the difference between the carrying amounts for items in the financial statements prepared in accordance with these significant financial reporting principles and those in the financial statements prepared in accordance with HGB net of deferred taxes.

Other insurance liabilities
Other insurance liabilities relating to non-life insurance have to include obligations arising from membership of the Verein Verkehrsopferhilfe e.V. (VOH) [road casualty support organization], Berlin, in line with the object of this organization and the provision for unearned premiums under dormant vehicle insurance policies, the provision being determined on an individual policy basis. The cancellation provision has to be calculated on the basis of past experience, whereas operational planning has to be used as the basis for measuring the premium deficiency provision.

Other insurance liabilities for life insurance have to be computed on the basis of individual policies from premiums that are already due but have yet to be paid and have not yet been included in the life insurance liability to the extent that the investment risk is borne by the policyholders.

A cancellation provision has to be recognized within other insurance liabilities for health insurance. The cancellation provision has to be recognized to take account of expected losses and has to be calculated on the basis of empirical values relating to the premature loss, not previously accounted for, of the negative portions of the provision for increasing age.

Cooperative Financial Network as lessor
If a lease is classified as a finance lease, a receivable due from the lessee must be recognized. The receivable is measured at an amount equal to the net investment in the lease at the inception of the lease. Lease payments are apportioned into payment of interest and repayment of principal. The interest portion is recognized as interest income on an accrual basis.

If a lease is classified as an operating lease, the lessor retains beneficial ownership of the leased asset. These leased assets are reported as assets. The leased assets are measured at cost less depreciation and any impairment losses. Unless another systematic basis is more representative of the pattern of income over time, lease income is recognized in profit or loss on a straight-line basis over the term of the lease and is included in the current income from operating leases reported under net interest income.

Cooperative Financial Network as lessee

If a lease is classified as a finance lease, the leased asset must be recognized as an asset at the lower of fair value and the present value of the minimum lease payments. A liability of an equivalent amount is also recognized. The interest expenses have to be recognized on an accrual basis.

Lease payments under operating leases have to be recognized on an accrual basis over the term of the leases concerned and reported as administrative expenses.

Income

Interest and dividends received

Interest income is accrued and recognized in the relevant period.

Premiums and discounts are allocated over the expected life of financial instruments. Any additional directly attributable transaction costs also have to be recorded on an accrual basis and amortized over the term when these are directly connected with the acquisition or sale of a financial asset or a financial liability. Such costs include sales charges directly associated with the origination of home savings contracts.

Interest income and interest expense arising in connection with derivatives that were not entered into for trading purposes or are used to hedge financial instruments designated as at fair value through profit or loss are reported under net interest income.

Cash and cash equivalents

Cash on hand, balances with central banks and other government institutions, treasury bills, and non-interest-bearing treasury notes have to be recognized as cash and cash equivalents.

Holdings of cash denominated in euros or foreign currencies have to be included in cash on hand. Cash in euros has to be measured at nominal value; foreign currency cash has to be translated at the buying rate. Balances with central banks and other government institutions, treasury bills, and non-interest-bearing treasury notes have to be classified as ‘loans and receivables’ and measured at amortized cost. Interest income on cash and cash equivalents has to be recognized as interest income from lending and money market business.

Loans and andvances to banks and customers

All receivables attributable to registered debtors not classified as ‘financial instruments held for trading’ have to be recognized as loans and advances to banks and customers. In addition to fixed-term receivables and receivables payable on demand in connection with lending, lease, and money market business, promissory notes and registered bonds have to be included in loans and advances to banks and customers.

Loans and advances to banks and customers are measured at amortized cost. In fair value hedges, the carrying amounts of hedged receivables are adjusted by the change in the fair value attributable to the hedged risk. The resulting hedge adjustments are recognized within other gains and losses on valuation of financial instruments under gains and losses arising on hedging transactions. To avoid or significantly reduce accounting mismatches, certain loans and advances are designated as at fair value through profit or loss. Finance lease receivables are recognized and measured in accordance with the requirements for the accounting treatment of leases.

Interest income on loans and advances to banks and customers is recognized as interest income from lending and money market operations. This also includes gains and losses on the sale of such loans and advances classified as “loans and receivables” and the amortization of hedge adjustments to carrying amounts due to fair value hedges.

Financial assets and financial liabilities held for trading

Financial assets and financial liabilities held for trading solely comprise financial assets and financial liabilities that fall within the measurement category “financial instruments held for trading”.

Derivatives with positive fair values are classified as financial assets held for trading if they were entered into for trading purposes or, despite being intended to be used as hedges, do not meet the requirements to be recognized as hedging instruments.

Financial instruments reported as financial assets or financial liabilities held for trading are always measured at fair value through profit or loss. Gains and losses on valuation, interest income and expense, and dividends arising from financial assets and financial liabilities held for trading are recognized under gains and losses on trading activities, provided that there is an actual intent to trade the instruments concerned.

Gains and losses on valuation of derivatives that are entered into for hedging purposes, but are not recognized as hedging transactions, have to be recognized under other gains and losses on valuation of financial instruments as gains and losses on derivatives used for purposes other than trading. If, to avoid accounting mismatches, hedged items are classified as ‘financial instruments designated as at fair value through profit or loss’, valuation gains and losses on the related derivatives concluded for hedging purposes have to be recognized under gains and losses on financial instruments designated as at fair value through profit or loss. Interest income and interest expense arising in connection with derivatives that were not entered into for trading purposes or are used to hedge financial instruments designated as at fair value through profit or loss have to be reported under net interest income.

Investments

The following have to be recognized as investments: bearer bonds and other fixed-income securities, shares and other variable-yield securities, and other bearer or registered shareholdings in entities in which the Cooperative Financial Network has no significant influence, provided that these securities or shares are not held for trading purposes.

Depreciation and impairment losses on property, plant and equipment, and investment property have to be recognized as administrative expenses. Reversals of impairment losses are reported under other net operating income/expense.

Income tax assets and liablities

Current and deferred tax assets have to be shown under the income tax assets balance sheet item; current and deferred tax liabilities have to be reported under income tax liabilities. Current income tax assets and liabilities have to be recognized in the amount of any expected refund or future payment.

Deferred tax assets and liabilities have to be recognized for temporary differences between the carrying amounts recognized in the consolidated financial statements and those in the financial statements for tax purposes. Deferred tax assets also have to be recognized in respect of as yet unused tax loss carryforwards, provided that utilization of these loss carryforwards is sufficiently probable. Deferred tax assets have to be measured using the national and entity-specific tax rates expected to apply at the time of realization.

Other assets

Intangible assets have to be reported under other assets and are recognized at cost. In the subsequent measurement of software, acquired customer relationships, and other intangible assets with a finite useful life, carrying amounts have to be reduced by cumulative amortization and cumulative impairment losses. Goodwill and other intangible assets with an indefinite useful life do not have to be amortized but have to be subjected to an impairment test at least once during the financial year in accordance with IAS 36.7–57.

Non-current assets and disposal groups classified as held for sale

The carrying amount of non-current assets or disposal groups for which a sale is planned is recovered principally through a sale transaction rather than through their continuing use. These assets and disposal groups therefore need to be classified as held for sale if the criteria set out below are satisfied.

To be classified as held for sale, the assets or disposal groups must be available for immediate sale in their present condition subject only to terms that are usual and customary for sales of such assets or disposal groups, and it must be highly probable that a sale will take place.

Interest expense on deposits from banks and customers are recognized separately under net interest income. Interest expense also includes gains and losses on early repayment and on the amortization of hedge adjustments to carrying amounts due to fair value hedges. Hedge adjustments to the carrying amount due to fair value hedges are reported within other gains and losses on valuation of financial instruments under gains and losses arising on hedging transactions. If liabilities are designated as at fair value through profit or loss, the gains and losses on valuation are recognized under the same item as part of other gains and losses on valuation of financial instruments.

Debt certificates issued including bonds

‘Pfandbriefe’, other bonds, and other debt certificates issued for which transferable bearer certificates have been issued have to be recognized as debt certificates issued including bonds.

Debt certificates issued including bonds and gains and losses thereon have to be measured and recognized in the same way as deposits from banks and customers.

Provisions

Provisions are liabilities in which the amounts or due dates are uncertain. Provisions have to be recognized for present obligations arising out of past events, in which it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and the amount of the obligation can be reliably estimated.

The provisions have to be recognized and measured using the best estimate of the present value of their anticipated utilization. This estimate has to take account of future events as well as the risks and uncertainties relating to the issue concerned.

Provisions for defined benefit plans

Where a commitment is made to defined contribution plans, fixed contributions have to be paid to external pension providers. The amount of the contributions and the income earned from the pension assets determine the amount of future pension benefits. The risks arising from the obligation to pay such benefits in the future lie with the pension provider. No provisions have to be recognized for these indirect pension commitments. The contributions paid have to be recognized as pension and other post-employment benefit expenses under administrative expenses.

These bonuses may take the form of a reimbursement of some of the sales charges or interest bonuses on deposits.

Residual provisions

Further provisions for employee benefits, such as provisions for other long-term employee benefits (e.g. semi-retirement (Altersteilzeit) schemes), provisions for termination benefits (e.g. early retirement schemes), and provisions for short-term employee benefits, have to be included under other provisions.

Residual Provisions for restructuring also have to be included under other provisions, as do provisions for risks arising from ongoing legal disputes. The latter have to be recognized when the reasons indicating that a legal dispute will result in a payment obligation are stronger than those indicating the opposite. The amount in which such provisions are recognized is based on the potential resulting losses.

Subordinated capital

All registered or bearer debt instruments that, in the event of insolvency or liquidation, are repaid only after settlement of all unsubordinated liabilities but before distribution to shareholders of any proceeds from the insolvency or liquidation have to be included in subordinated capital.

Subordinated capital and gains and losses on this capital have to be measured and recognized in the same way as deposits from banks and customers.

Equity

Equity has to represent the residual value of the Cooperative Financial Network’s assets minus its liabilities. Cooperative shares of the independent local cooperative banks and capital of silent partners have to be treated as economic capital in the consolidated financial statements and recognized as equity. Subscribed capital – consisting of cooperative shares or share capital and liabilities to dormant partners – and capital reserves of the local cooperative banks have to be included in equity.

• Disclosures on capital adequacy and regulatoryratios:
  • The disclosures have to refer to the institutional protection scheme (cooperative joint liability scheme). The disclosures relating to own funds and capital requirements have to be based on the information from the extended aggregated calculation in accordance with article 49 (3) CRR in conjunction with article 113 (7) CRR.
  • The leverage ratio for the Cooperative Financial Network’s institutional protection scheme as at December 31, 2017 has to be reported in accordance with the methodology specified in article 429 CRR. The capital measure used has to be Tier 1 capital as determined in the extended aggregated calculation in accordance with article 49 (3) CRR, which has to be adjusted for all internal Tier 1 capital positions within the joint liability scheme of the members of the institutional protection scheme. The risk exposures have to be determined by aggregating the individual leverage ratio submissions of all the member banks and adjusted for material internal exposures within the joint liability scheme.
  • The primary banks and Münchener Hypothekenbank have to be included individually on the basis of their respective submissions. DZ BANK’s submission has to be included on a consolidated basis. The DZ BANK Group’s submission has to be based on the regulatory scope of consolidation.
  • The underlying submissions of the members of the institutional protection scheme (IPS) as at December 31, 2017 have to be based on Implementing Regulation (EU) No. 680/2014, which was amended by Implementing Regulation (EU) No. 2016/428 to reflect the changes to Delegated Regulation (EU) No. 2015/62 of October 10, 2014.