ESRB response on the request for information for post-implementation Review of IFRS 9 Financial Instruments – Impairment

The European Systemic Risk Board (ESRB) has published its response to the Post-implementation Review IFRS 9 Financial Instruments Impairment in which it highlights several issues related to the Expected Credit Loss (ECL) approach in International Financial Reporting Standards (IFRS) 9 that merit attention from a financial stability perspective.
According to the ESRB, the introduction of the ECL approach in IFRS 9 represented a paradigm shift from the previous IAS 39 standard, requiring a higher degree of sophistication in terms of data and modelling. Challenges in the application thereby arise from the lack of relevant data and experience, as well as the role of managerial judgement in the modelling process.
The implementation of IFRS 9 has led many institutions to „upgrade their data infrastructure and their internal governance processes to meet the requirements in the standard“. Despite the additional costs and the challenges faced by institutions (as noted above), the ESRB is convinced that the benefits brought about by IFRS 9 far outweigh the costs associated with it. Nevertheless, from a financial stability perspective, the ESRB would greatly appreciate targeted measures, particularly in the area of measuring expected credit losses.
Specifically, the ESRB believes that more guidance should be provided regarding the use of macroeconomic scenarios for ECL estimation and sensitivity analysis. This guidance should include factors such as the time horizon of the scenario, the use of economic forecasts by central banks or international organizations, the weighting of different scenarios, and approaches to revert to long-term averages beyond the forecast period.
Furthermore, the ESRB is concerned about the use of management adjustments and overlays in the assessment of a significant increase in credit risk. While the use of overlays during the pandemic was justified due to the unique circumstances and lack of historical data, the discretion allowed by IFRS9 has led to reduced transparency and hinders comparability of disclosures, potentially interfering with market discipline in risk-taking. Therefore, it is important to carefully consider the impact of overlays and ensure that they are used appropriately and transparently. In same context, the Board also notes that some banks continue to use expert judgement and overlays, which may result in lower coverage ratios and conflicts with the principles of IFRS 9. Therefore, the ESRB pledges for more guidance on the thresholds used in the assessment of a significant increase in credit risk, as well as better disclosures on the impact of overlays and post-model adjustments.