NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 121 Lease financing transactions Trading assets Cash and cash equivalents Deferred tax assets The allowance for loan losses represents management’s estimate of probable losses that have occurred in the loan portfolio and other lending-related commitments as of the date of the consolidated fi- nancial statements. The allowance for loan losses is reported as a re- duction of assets, the provisions for contingent liabilities, such as guarantees, loan commitments and other obligations are carried as liabilities. To allow management to determine the appropriate level of the allowance for loan losses, all significant counterparty relationships are periodically reviewed. A specific allowance is established to pro- vide for specifically identified counterparty risks. Specific allowances are established for impaired loans. The amount of the impairment is based on the present value of expected future cash flows or based on the fair value of the collateral if the loan is collateralized and fore- closure is probable. If the amount of the impairment subsequently in- creases or decreases due to an event occurring after the initial meas- urement of impairment, a change in the allowance is recognized in earnings by a charge or a credit to net loan loss provisions. A lump-sum specific allowance is established to provide for in- curred but unidentified losses that are inherent in the loan portfolio as of the balance sheet date. The amount of the allowance is based on historical loss experience and management’s evaluation of the loan portfolio under current events and economic conditions. A country risk allowance is established for transfer risk. Transfer risk is a measure of the likely ability of a borrower in a certain country to repay its foreign currency-denominated debt in light of the eco- nomic or political situation prevailing in the country. Country risk allowances are based on a country risk rating system that incorporates current and historical economic, political and other data to categorize countries by risk profile. Loans are charged-off when, based on management’s judgement, all economically sensible means of recovery have been exhausted. At the point of charge-off, the loan as well as any specific allowance associated with the loan must be removed from the balance sheet and a charge may be recorded to directly charge-off the loan. A charge-off may be full or partial. Subsequent to a charge-off, recov- eries, if any, are recognized in the income statement as a credit to net loan loss provisions. The provision for loan loss, which is charged to net income, is the amount necessary to adjust the allowance to a level determined through the process described above. Loans and advances to banks and customers include the Group’s gross investment in leases, less unearned finance income relating to lease financing transactions for which the Group is the lessor. The gross investment in leases is the aggregate of the minimum lease payments and any unguaranteed residual value accruing to the Group. Lease financing transactions include direct financing leases and leveraged leases. The unearned finance income is amortized over the period of the lease so as to produce a constant periodic rate of re- turn on the net investment outstanding in respect of the finance lease. These consist of debt and equity securities, derivatives with positive market values, promissory note loans and precious metal holdings that have been acquired solely for sale in the near term. They are classified as “Held for trading” on account of their purpose and are reported at fair value. Changes in fair value are recognized directly in the income statement. Exchange-traded financial instruments are valued at the exchange prices prevailing on the last exchange trad- ing day of the year. To determine the market values of unlisted fi- nancial instruments, quotations of similar instruments or acknowl- edged valuation models (in particular present value models or option pricing models) are used. Creditworthiness, settlement costs and mar- ket liquidity are also taken into account as integral components of the valuation process. Realized gains and losses on securities are in all cases calculated on the basis of the average cost method. This item includes balances with banks payable on demand, balances with central banks, checks and cash on hand, treasury bills (to the extent that they are not included in trading assets), and bills of ex- change which are eligible for refinancing at central banks, subject to a maximum term of 6 months from the date of acquisition. Cash funds are stated at their face value, with holdings of foreign notes and coins valued at year-end closing prices. The calculation of deferred taxes is based on temporary differences between the carrying amounts of assets or liabilities in the published balance sheet and their tax bases, and on differences arising from the application of uniform valuation policies for consolidation purposes as well as consolidation in the income statement. The tax rates used for the calculation of deferred taxes are the local rates applicable in the countries concerned; changes to tax rates already adopted as of the balance sheet date are taken into account. Deferred tax assets are recognized if sufficient future taxable income is available for realiza- tion. Safety margins are applied if appropriate.