The EBA’s monitoring of IFRS 9 implementation by EU institutions confirms need to timely address practices misaligned with expectations

• Expected credit loss (ECL) models now lead to timelier recognition of loss provisions. However, most findings confirm previously raised issues and some divergence with the EBA’s expectations on IFRS 9 implementation.
• Overlays are becoming an integral part of the ECL framework and therefore, more efforts are needed to reduce the high degree of judgment for their calibration. Their usage under robust methodological and sound governance frameworks needs to be better framed.
• Backtesting is a key area that requires further investments by institutions to enlarge scope and robustness of the analysis and to improve the use of the backtesting results for the periodic review of IFRS 9 models.

The European Banking Authority (EBA) today published its second Report on the International Financial Reporting Standard (IFRS) 9 implementation by EU institutions complementing the observations already included in the last IFRS 9 Monitoring Report, published in November 2021. This Report focuses on high default portfolios (HDPs) and aims to promote further improvements in the ECL model practices among EU institutions by providing transparency on the major areas of concern identified by the EBA.  In line with the IFRS 9 Roadmap, the EBA will continue monitoring and promoting the consistent application of IFRS 9.

Main observations

Since the date of the first implementation of IFRS 9, institutions have made significant progress in the implementation of their ECL impairment models despite a challenging environment. According to benchmarking analyses, the existence of a variety of practices – as a result of the principle-based nature of the standard – might explain part of the variability observed among institutions on the final ECL fig­ures of HDPs. Some of these practices continue to raise prudential concerns and are expected to be promptly addressed by EU institutions.

The EBA reiterates the importance of relying on a robust and broad set of significant increases in credit risk (SICR) indicators to assess staging transfers. The persistent lack of collective SICR as­sessment and the different approaches followed by some institutions to determine the SICR quantitative thresholds continue to be areas of concern from a prudential perspective.

Overlays, being temporary or more permanent, have allowed institutions to account for risk factors or specific circumstances not adequately captured by models. Different practices have been ob­served in terms of risks consideration, approaches followed for their calibration and level at which these overlays are applied. This may prevent reflecting any additional sources of risk.

The impact of forward-looking information and non-linearity effect remains generally modest across portfolios. Among others, this may stem from the fact that the assump­tions underlying the macroeconomic fore­casts, the use of excessively long forecasting period and some smoothening practices prevent reflecting the point in time and forward looking nature of IFRS figures.

Finally, the EBA has observed that while institutions have generally de­veloped backtesting methodologies for their ECL models, there are important differences among banks with reference to the state of their implementation, the scope of risk factors under consideration (including overlays) and the type of anal­ysis performed.  A lack of proper follow-up actions on backtesting results raises prudential concerns, es­pecially when tests performed reveal underperformances and low predictive pow­ers of the model estimates.

Next steps

The EBA will continue monitoring and promoting the consistent application of IFRS 9. The observations reported in the current and past monitoring reports will also feed future exchanges with all concerned stakeholders on IFRS 9 implementation – including any further debates on the post implementation review of IFRS 9. The benchmarking exercise will continue to be used to foster a consistent implementation of the standard. Supervisors will continue to ensure a high quality and consistent application of IFRS 9 implementation and a follow up of the main findings of the EBA reports.

Legal basis and background

This Report has been published by the EBA in line with its intention to continue scrutinising the implementation of IFRS 9 in the EU, as communicated in the IFRS 9 Roadmap, published in July 2019. In this context, this report summarises the findings from monitoring activities conducted by the EBA, specifically on HDPs. The publication complements the main findings of the previous IFRS 9 Monitoring Report, published in November 2021.