ECB Credit Risk Supervision: IFRS 9 Provisioning, Forbearance, and Leveraged Lending Under the Microscope
The European Central Bank has made credit risk oversight one of its sharpest supervisory edges. Its focus on IFRS 9 loan loss provisioning, forbearance identification, and leveraged lending exposure has intensified across the supervised banking population, and the implications reach directly into how finance teams, auditors, and CFOs design and defend their credit risk frameworks. This is not a theoretical concern: the ECB has already dispatched Operational Act letters to selected banks and launched an on-site inspection campaign targeting major portfolio segments.
Why the ECB Is Pushing Harder on Credit Risk Now
Macroeconomic Pressure as a Supervisory Catalyst
The ECB's stepped-up scrutiny is grounded in a specific set of macroeconomic conditions. Higher financing costs are squeezing the corporate sector, and small and medium-sized enterprises, which recovered more slowly from recent disruptions, carry particular vulnerability. Leveraged loans, by their nature sensitive to interest rate movements, have drawn supervisory concern that any further tightening of financial conditions could accelerate credit deterioration in that segment.
Property markets add another layer. The ECB has flagged that the euro area residential real estate market appears to be entering a correction phase, where falling valuations combined with higher mortgage costs could erode household balance sheets. The commercial real estate segment is under similar strain, with declining valuations and weakened demand in office and retail. Both trends feed directly into banks' collateral assessments and, by extension, their IFRS 9 staging and provisioning decisions.
The ESRB's Corroborating View
The General Board of the European Systemic Risk Board has separately assessed financial stability risks in the EU as severe. That alignment between the ESRB and the ECB signals that heightened supervisory scrutiny on credit risk is not temporary. Firms should expect this emphasis to persist and intensify rather than ease.
IFRS 9 Provisioning: Where Banks Are Falling Short
Novel Risks and Legacy Models
The ECB's review of IFRS 9 provisioning frameworks across 51 supervised institutions revealed a clear pattern of inadequacy when it comes to novel risks. Energy transition, supply chain fragility, inflationary pressure, geopolitical instability, and environmental factors are not consistently captured in banks' expected credit loss models. A striking finding: 80% of banks reviewed do not factor environmental risk into their provisioning at all.
A further problem lies in model vintage. Some institutions are still relying on IFRS 9 macro-overlay models built before 2018. The ECB has been direct: models designed in that era were not built to reflect the credit risk dynamics of the current environment, and continued reliance on them is not acceptable as a long-term approach.
Overlays: Useful but Governed
The ECB has acknowledged that in-model adjustments and evidence-based overlays are legitimate tools for capturing emerging risks. However, those overlays must be risk-sensitive, granular, and supported by strong governance. Broad, judgment-heavy umbrella overlays that lack sectoral quantification or client-level identification will not satisfy supervisory expectations. The ECB's preferred approach requires banks to design evidence-based methodologies, quantify risks at a sectoral level, and identify which borrower groups are exposed to each risk factor.
For accounting teams supporting credit institutions, this translates into a documentation challenge as much as a modelling one. The ability to demonstrate how novel risks are identified, quantified, and reflected in provisions, backed by auditable governance, is now a baseline expectation rather than good practice.
Forbearance and Unlikely-to-Pay Classification
Recurring Weaknesses Identified by the ECB
Forbearance has become a focal point after the ECB found too many supervised banks falling short of expectations in assessments conducted over the prior year. The ECB has since informed banks that it is conducting deep dives specifically on forbearance, with some institutions already notified of assessments beginning in the second half of the year.
Three recurring gaps define the ECB's concerns. First, early identification of borrowers in financial difficulty: the ECB expects this to be grounded in both quantitative and qualitative criteria, supported by functional early warning systems rather than reactive monitoring. Second, concession design and approval: forbearance measures must be assessed for affordability using scenario-based projections, supported by a complete toolkit and a documented decision process. Third, ongoing monitoring of forborne exposures: the ECB expects timely escalation as a client's financial position deteriorates, at both individual and portfolio level.
Practical Pressure on Finance and Audit Teams
What this means in practice is that the administrative and analytical burden on credit risk teams is rising. Forbearance classification decisions need to be defensible at the point of supervisory review, which means contemporaneous documentation, scenario modelling for each concession, and a clear audit trail from early warning trigger to forbearance approval to ongoing watch. Auditors reviewing credit portfolios should expect the ECB's forbearance standards to serve as an implicit benchmark when assessing whether a bank's approach is reasonable.
Leveraged Lending: Capital Add-Ons and Operational Act Letters
ECB Enforcement Mechanisms in Practice
The ECB's assessment of banks' leveraged lending practices has moved from guidance into enforcement action. Operational Act letters sent to selected banks during the first half of the year identify institution-specific gaps and feed those findings directly into the Supervisory Review and Evaluation Process. Banks with unresolved weaknesses in risk appetite frameworks, risk controls, or monitoring procedures face capital add-ons at the Pillar 2 Requirement level, applied specifically because of leveraged lending risk.
The ECB has been reviewing banks' progress against its 2017 leveraged lending guidance and its 2022 supervisory expectations, assessing how well institutions have embedded those expectations into their operating frameworks. For banks with material leveraged loan books, the message is unambiguous: the ECB will use its capital tools if risk management shortcomings persist.
CRE Portfolios and Broadening IFRS 9 On-Site Inspections
From Valuation to Risk Classification
On-site inspections of commercial real estate portfolios have expanded in scope. Earlier cycles focused primarily on collateral valuation frameworks. The current focus has broadened to include the accuracy of risk classifications, IFRS 9 stage transfers, and impairment recognition. CRE assessments are now being integrated into broader IFRS 9 on-site inspection campaigns rather than treated as standalone exercises.
This integration matters for accounting and audit teams. A CRE portfolio review is no longer solely a property valuation exercise. It encompasses the full IFRS 9 lifecycle: initial staging, transfer triggers, overlay governance, and the linkage between portfolio-level deterioration signals and individual impairment decisions. Teams that treat these as separate workstreams may find supervisory findings span both.
The ECB's 2023 OSI campaign covers large corporate, CRE, SME, and retail portfolios, meaning exposure to the supervisory lens is broad. Accounting firms advising credit institutions across any of these segments should be preparing clients for the level of documentation and analytical rigour the ECB expects to find.
The ESMA's MiCA white paper exemption guidance for EU firms reflects a parallel trend of EU regulators increasing transparency over exactly how they will assess compliance, a pattern visible in the ECB's newly published standardised SREP credit risk methodology as well.
Basel IV: The Horizon Pressure
A provisional agreement on the EU's implementation of Basel IV was reached in June 2023. While the final text was expected from September 2023 and the implementation date remains 1 January 2025, the implications for credit risk management are broad. Banks will need to assess Basel IV's impact on policies, processes, data infrastructure, and capital quantification across their portfolios. The timeline is tight, and the credit risk frameworks being scrutinised by the ECB today will need to absorb those changes without supervisory gaps emerging in the interim.
For finance and accounting teams, this means the IFRS 9 and credit risk governance work being done now cannot be treated as a one-cycle exercise. It feeds directly into Basel IV readiness. Separately, firms managing digital asset exposures should note that the intersection of IFRS 9 provisioning principles and emerging standards for digital asset accounting is an area where early preparation pays dividends, particularly as the EU regulatory perimeter continues to expand under MiCA. Our overview of the EU ViDA 2026 implementation roadmap illustrates how multiple EU regulatory streams are converging on tighter documentation and reporting standards simultaneously.
FAQ
What specific IFRS 9 areas is the ECB currently scrutinising in on-site inspections?
The ECB's current OSI campaign covers IFRS 9 provisioning across large corporate, commercial real estate, SME, and retail portfolios. Inspectors are examining stage transfer accuracy, overlay governance, how novel risks are quantified, and whether provisions reflect the current macroeconomic environment. CRE assessments have been integrated into these broader IFRS 9 inspections rather than remaining standalone reviews.
What does the ECB expect from IFRS 9 overlays, and when are they acceptable?
The ECB accepts in-model adjustments and evidence-based overlays as legitimate tools for capturing emerging risks. However, it requires that overlays are risk-sensitive, supported by strong governance, quantified at a sectoral level, and linked to identified client groups. Broad judgment-based umbrella overlays without that granularity do not meet supervisory expectations.
What are the key forbearance gaps the ECB has identified across supervised banks?
The ECB has highlighted three recurring weaknesses: insufficient early identification of borrowers in difficulty, poorly designed or unapproved concessions lacking affordability projections under multiple scenarios, and inadequate ongoing monitoring of forborne exposures at both individual and portfolio level. Deep dive assessments focused on these gaps were planned to begin in the second half of 2023.
How does the ECB use capital add-ons in relation to leveraged lending?
Where banks have excessively high perceived leveraged lending risk and their risk appetite frameworks, controls, or monitoring procedures remain unsatisfactory, the ECB applies capital add-ons at the Pillar 2 Requirement level. Banks are being assessed against the ECB's 2017 guidance and 2022 supervisory expectations, with Operational Act letters sent to those with identified gaps that feed into the SREP.
How does Basel IV interact with the IFRS 9 credit risk work banks are doing now?
Basel IV implementation, targeted for 1 January 2025 in the EU, will affect credit risk policies, data requirements, and capital quantification across portfolios. Banks investing in IFRS 9 governance and modelling improvements now need to ensure those frameworks can absorb Basel IV requirements without creating new supervisory gaps. The two streams of work are not independent.
Source: KPMG Digital Assets