Page 88 - Annual Report 2022

Banka Kombëtare Tregtare Annual Report 2022 26

Banka Kombëtare Tregtare Sh.a.
Notes to the Consolidated Financial Statements for the year ended
31 December 2022 (Amounts in USD, unless otherwise stated)

4. Use of estimates and judgements (continued)
Determining fair values

The determination of fair value for financial assets and liabilities for which there is no observable market price requires the use of
valuation techniques as described in accounting policy 3 (g) (viii). For financial instruments that trade infrequently and have little
price transparency, fair value is less objective, and requires varying degrees of judgment depending on liquidity, concentration,
uncertainty of market factors, pricing assumptions and other risks affecting the specific instrument. See also “Valuation of
financial instruments” below.
Critical accounting judgments made in applying the Bank’s accounting policies include:
Valuation of financial instruments

The Bank’s accounting policy on fair value measurements is discussed under note 3 (g) (viii).
The Bank measures fair values using the following hierarchy of methods:
• Level 1: Quoted market price in an active market for an identical instrument.
• Level 2: Valuation techniques based on observable inputs. This category includes instruments valued using: quoted market
prices in active markets for similar instruments; quoted prices for similar instruments in markets that are considered less than
active; or other valuation techniques where all significant inputs are directly or indirectly observable from market data.
• Level 3: Valuation techniques using significant unobservable inputs. This category includes all instruments where the valuation
technique includes inputs not based on observable data and the unobservable inputs could have a significant effect on the
instrument’s valuation. This category includes instruments that are valued based on quoted prices for similar instruments
where significant unobservable adjustments or assumptions are required to reflect differences between the instruments.

Fair values of financial assets and financial liabilities that are traded in active markets are based on quoted market prices or
dealer price quotations. For all other financial instruments the Bank determines fair values using valuation techniques. Valuation
techniques include net present value and discounted cash flow models, comparison to similar instruments for which market
observable prices exist and other valuation models. The objective of valuation techniques is to arrive at a fair value determination
that reflects the price of the financial instrument at the reporting date that would have been determined by market participants
acting at arm’s length.

The Bank uses widely recognized valuation models for determining the fair value of common and more simple financial
instruments, like interest rate and currency swaps that use only observable market data and require little management judgment
and estimation. Observable prices and model inputs are usually available in the market for listed debt and equity securities,
exchange traded derivatives and simple over the counter derivatives like interest rate swaps. Availability of observable market
prices and model inputs reduces the need for management judgment and estimation and also reduces the uncertainty associated
with determination of fair values. Availability of observable market prices and inputs varies depending on the products and
markets and is prone to changes based on specific events and general conditions in the financial markets.
For more complex instruments, the Bank uses proprietary valuation models, which usually are developed from recognized
valuation models. Some or all of the significant inputs into these models may not be observable in the market, and are derived
from market prices or rates or are estimated based on assumptions. Valuation models that employ significant unobservable
inputs require a higher degree of management judgment and estimation in determination of fair value. Management judgment
and estimation are usually required for selection of the appropriate valuation model to be used, determination of expected future
cash flows on the financial instrument being valued, determination of probability of counterparty default and prepayments and
selection of appropriate discount rates.