Banking Law and the IFRS 9 Expected Credit Loss Model in Spain

1. Introduction

IFRS 9 is the principal accounting standard governing the classification, measurement and impairment of financial instruments. It replaced IAS 39 and became applicable in the European Union, including Spain, on 1 January 2018.

For Spanish banks, the most important reform introduced by IFRS 9 was the Expected Credit Loss model, commonly called the ECL model. Under the previous incurred-loss approach, a bank generally recognised impairment only after objective evidence of loss appeared. IFRS 9 requires banks to recognise expected losses before the borrower actually defaults.

The model is intended to ensure:

• Earlier recognition of credit deterioration.
• More realistic measurement of loan losses.
• Consideration of future economic conditions.
• Timely recognition of provisions.
• Greater transparency for investors, depositors and supervisors.
• Stronger credit-risk governance.

In Spain, IFRS 9 operates together with Banco de España Circular 4/2017, EU accounting legislation, banking-supervision rules, the Capital Requirements Regulation, EBA guidance and ECB supervisory expectations.

2. Spanish Legal and Regulatory Framework

2.1 IFRS 9 as EU Law

International accounting standards do not automatically become binding merely because the International Accounting Standards Board issues them. They become legally applicable in the European Union after endorsement through EU legislation.

IFRS 9 was endorsed by Commission Regulation (EU) 2016/2067. Spanish listed groups, including listed banking groups, must therefore apply EU-endorsed IFRS to their consolidated financial statements.

2.2 Banco de España Circular 4/2017

Banco de España Circular 4/2017 is the central Spanish regulatory instrument dealing with the accounting and financial reporting obligations of credit institutions.

It aligns Spanish banking-accounting rules with EU-adopted IFRS 9 and contains detailed provisions on:

• Credit-risk classification.
• Impairment of financial assets.
• Identification of performing and non-performing exposures.
• Individual and collective loss estimation.
• Collateral valuation.
• Refinanced and restructured operations.
• Write-offs.
• Financial reporting to the Banco de España.
• Internal governance of credit-risk provisions.

Annex 9 of Circular 4/2017 is particularly important. It provides definitions, indicators and practical methodologies for credit-risk classification and impairment.

2.3 European Banking Authority Guidance

Spanish banks must also consider EBA guidelines concerning credit-risk management and expected credit losses.

The EBA expects institutions to establish:

• Sound credit-granting standards.
• Reliable systems for identifying credit deterioration.
• Independent validation of ECL models.
• Proper documentation of management judgments.
• Controls over forward-looking economic scenarios.
• Regular back-testing.
• Appropriate board supervision.

2.4 ECB Supervision

Large Spanish banks are directly supervised by the European Central Bank under the Single Supervisory Mechanism. Smaller institutions are directly supervised by the Banco de España, subject to the overall European framework.

The ECB can examine whether:

• Loans are placed in the correct IFRS 9 stage.
• Significant increases in credit risk are recognised promptly.
• Default and cure criteria are appropriate.
• Macroeconomic scenarios are sufficiently conservative.
• Collateral values are realistic.
• Management overlays are justified.
• Models underestimate expected losses.

The ECB cannot simply rewrite IFRS 9, but accounting weaknesses may result in supervisory measures, additional capital expectations or required corrections.

3. Scope of the ECL Model

The expected-credit-loss requirements generally apply to:

• Loans and advances measured at amortised cost.
• Debt securities measured at amortised cost.
• Debt instruments measured at fair value through other comprehensive income.
• Trade and lease receivables.
• Contract assets.
• Loan commitments not measured at fair value through profit or loss.
• Financial guarantee contracts.
• Certain interbank exposures.

The model generally does not apply to:

• Equity instruments.
• Financial assets measured at fair value through profit or loss.
• Instruments whose credit risk is already fully reflected through fair-value changes recognised in profit or loss.

4. Meaning of Expected Credit Loss

An expected credit loss is the present-value estimate of the cash shortfall that a bank expects to suffer.

A cash shortfall is the difference between:

• The contractual cash flows legally due to the bank; and
• The cash flows the bank realistically expects to receive.

ECL is not merely the amount of instalments already overdue. It includes the probability of future non-payment, possible recoveries, collateral realisation, enforcement costs, timing delays and forward-looking economic conditions.

A common simplified expression is:

ECL=PD×LGD×EADECL = PD \times LGD \times EAD

Where:

• PD — Probability of Default: Likelihood that the borrower will default.
• LGD — Loss Given Default: Percentage of the exposure likely to be lost if default occurs.
• EAD — Exposure at Default: Amount expected to be outstanding when default happens.

A more complete model also includes:

• Discounting.
• Prepayment assumptions.
• Credit-conversion factors.
• Cure rates.
• Recovery timing.
• Collateral expenses.
• Multiple economic scenarios.
• Scenario probability weights.

5. The Three-Stage Model

Stage 1: Performing Exposures

A financial asset is normally placed in Stage 1 when it is first recognised, unless it is already credit-impaired.

The bank recognises 12-month expected credit losses.

This does not mean losses expected during the next 12 months. It means the lifetime losses resulting from defaults that are possible during the 12 months following the reporting date.

Interest income is normally calculated on the asset’s gross carrying amount.

Example

A Spanish bank grants a €100,000 mortgage to a financially stable customer. The loan is performing and no significant increase in credit risk has occurred.

The bank recognises the expected lifetime loss associated with a default that could occur during the following 12 months.

Stage 2: Significant Increase in Credit Risk

An exposure moves to Stage 2 when credit risk has increased significantly since initial recognition, even if the borrower has not yet defaulted.

The bank must then recognise lifetime expected credit losses.

Interest income generally continues to be calculated on the gross carrying amount.

Possible indicators include:

• Material increase in the probability of default.
• Significant fall in the borrower’s internal credit rating.
• Payments more than 30 days past due.
• Adverse changes in income or cash flow.
• Serious financial difficulties.
• Deterioration in the relevant industry.
• Forbearance or restructuring.
• Substantial fall in collateral value.
• Adverse macroeconomic developments.
• Placement on a special-monitoring or watch list.

The 30-days-past-due test is a rebuttable presumption. A bank may rebut it only with reasonable, supportable and properly documented evidence.

Stage 3: Credit-Impaired Exposures

Stage 3 covers financial assets that have become credit-impaired.

Typical indicators include:

• Serious financial difficulty.
• Default or substantial delinquency.
• Unlikely-to-pay status.
• Distressed restructuring.
• Bankruptcy or insolvency proceedings.
• Enforcement against collateral.
• Concessions that the bank would not otherwise grant.

Lifetime expected credit losses must be recognised.

Interest revenue is generally calculated using the effective interest rate on the net carrying amount, after deducting the loss allowance.

Stage 3 is broadly connected with the prudential concept of non-performing exposure, although accounting and prudential classifications are not always identical.

6. Significant Increase in Credit Risk

The identification of a significant increase in credit risk, or SICR, is one of the most difficult parts of IFRS 9.

The bank must compare:

• The risk of default at the reporting date; with
• The risk of default when the instrument was initially recognised.

The bank should not simply compare the current loan with other loans in the portfolio. IFRS 9 requires an assessment of deterioration relative to the original risk of that particular exposure.

Relevant information may include:

• Internal and external ratings.
• Behavioural payment information.
• Credit-card utilisation.
• Changes in income.
• Unemployment.
• Debt-service capacity.
• Loan-to-value ratio.
• Covenant breaches.
• Sector-specific weakness.
• Refinancing requests.
• Negative credit-register information.
• Macroeconomic forecasts.

Collective assessment

Some deterioration cannot be detected at the individual borrower level immediately. Spanish banks must therefore use collective assessment for groups sharing common characteristics, such as:

• Mortgages in the same geographical area.
• Loans to tourism businesses.
• Consumer loans to similar income groups.
• Loans to energy-intensive companies.
• Exposures affected by the same interest-rate shock.

A bank should not delay Stage 2 classification until an individual borrower misses payments if portfolio-level evidence already demonstrates increased risk.

7. The 12-Month and Lifetime ECL Distinction

12-month ECL

This covers lifetime losses associated with default events possible within the next 12 months.

Lifetime ECL

This covers losses arising from all possible default events over the expected life of the financial instrument.

For a long-term Spanish mortgage, lifetime ECL may include default risks extending over several decades. However, the bank must also estimate early repayment and refinancing behaviour.

For revolving facilities such as credit cards and overdrafts, the expected life may extend beyond the contractual cancellation period where the bank’s ordinary risk-management practice exposes it to credit risk for a longer period.

8. Forward-Looking Information

IFRS 9 prohibits reliance only on historical default information. Spanish banks must incorporate reasonable and supportable forecasts.

Relevant economic variables may include:

• Spanish GDP growth.
• Unemployment.
• Interest rates.
• Inflation.
• Residential property prices.
• Commercial real-estate values.
• Business insolvency rates.
• Energy prices.
• Tourism revenue.
• Export demand.
• Household disposable income.

Banks normally apply several scenarios:

1. Baseline scenario.
2. Optimistic or upside scenario.
3. Adverse or downside scenario.

Each scenario is assigned a probability weight.

Example

Assume a bank calculates the following lifetime losses:

The probability-weighted ECL is:

(10×50%)+(6×20%)+(24×30%)=13.4 million euros(10 \times 50\%) + (6 \times 20\%) + (24 \times 30\%) = 13.4\text{ million euros}

The bank cannot select only the most likely scenario if other scenarios could produce materially different credit losses.

9. Individual and Collective Assessment

Individual assessment

Large or specially risky exposures are usually assessed individually.

The bank estimates:

• Expected operating cash flows.
• Sale value of assets.
• Enforcement proceeds.
• Collateral value.
• Time required for recovery.
• Legal and administrative expenses.
• Possibility of restructuring.

Collective assessment

Smaller or homogeneous exposures may be assessed through statistical models.

Groups must share relevant risk characteristics. Excessively broad grouping may hide deteriorating loans. Excessively narrow grouping may make statistical estimates unreliable.

The bank should regularly review segmentation to reflect changing risk patterns.

10. Collateral and Guarantees

Collateral does not prevent a loan from being classified in Stage 2 or Stage 3. Classification primarily concerns the borrower’s credit risk, not merely whether sufficient collateral exists.

Collateral affects the measurement of loss given default.

The bank must consider:

• Current market value.
• Haircuts.
• Senior charges.
• Enforcement costs.
• Taxes.
• Time needed for possession and sale.
• Legal obstacles.
• Maintenance costs.
• Probability of successful enforcement.
• Guarantor’s ability to pay.

A €1 million loan secured by property valued at €1 million may still require a material loss allowance because the bank may receive less after enforcement costs and delayed recovery.

11. Refinancing and Forbearance

A loan does not become performing merely because the bank refinances it.

Forbearance exists where the bank grants a concession because the borrower faces, or is likely to face, financial difficulty.

Examples include:

• Reduced interest rates.
• Extended maturity.
• Payment holidays.
• Capitalisation of arrears.
• Partial debt forgiveness.
• Replacement of an overdue loan with a new facility.

A Spanish bank must determine whether restructuring:

• Produces a substantial contractual modification.
• Requires derecognition of the original asset.
• Indicates a significant increase in credit risk.
• Shows that the borrower is unlikely to pay.
• Requires Stage 2 or Stage 3 classification.

A sustained period of satisfactory performance is normally required before an exposure can return to a lower-risk category.

12. Write-Offs

A write-off occurs when the bank has no reasonable expectation of recovering all or part of the financial asset.

Writing off an asset:

• Reduces its gross carrying amount.
• Does not necessarily cancel the legal debt.
• Does not prevent further collection action.
• Must not be used to disguise inadequate earlier provisioning.

Recoveries received after write-off are normally recognised in profit or loss.

13. Purchased or Originated Credit-Impaired Assets

Purchased or originated credit-impaired assets are treated differently.

For these assets:

• Credit impairment exists at initial recognition.
• Lifetime ECL is incorporated into the credit-adjusted effective interest rate.
• Only subsequent changes in lifetime ECL are recognised as an impairment gain or loss.

This treatment may arise when a bank purchases a portfolio of defaulted or distressed Spanish loans at a deep discount.

14. Management Overlays

Statistical models may fail to capture unusual or rapidly developing risks. A bank may therefore apply a management overlay or post-model adjustment.

Examples include:

• A sudden geopolitical crisis.
• Pandemic-related uncertainty.
• Sharp increases in energy prices.
• Rapid interest-rate changes.
• Emerging weaknesses in commercial real estate.
• Model limitations affecting vulnerable borrowers.

Overlays must not become unexplained reserves. They should be:

• Supported by evidence.
• Approved through governance procedures.
• Quantified transparently.
• Regularly reassessed.
• Removed when incorporated into the underlying model.

15. Governance and Model Validation

The board remains responsible for ensuring reliable ECL reporting.

A sound governance structure should include:

• Clear responsibility between finance and risk departments.
• Independent model validation.
• Reliable credit data.
• Controls over model changes.
• Approval of macroeconomic scenarios.
• Back-testing against actual defaults and recoveries.
• Internal audit review.
• Documentation of expert judgment.
• Procedures for correcting model weaknesses.

External auditors must assess whether the impairment allowance represents a reasonable accounting estimate. However, the auditor’s opinion does not transfer responsibility away from the bank’s directors.

16. IFRS 9 and Prudential Capital

Accounting provisions and prudential expected losses serve related but different purposes.

IFRS 9 ECL

• Used for financial reporting.
• Based on point-in-time and forward-looking information.
• Measures 12-month or lifetime expected losses.
• Applies different measurement requirements according to the accounting stage.

Prudential expected loss

• Used in regulatory-capital calculations.
• May use through-the-cycle parameters.
• Is governed by the Capital Requirements Regulation.
• May produce amounts different from accounting provisions.

Where accounting provisions are lower than prudential expected losses, the difference may reduce Common Equity Tier 1 capital for banks using internal-ratings-based approaches. Excess provisions may receive limited recognition in Tier 2 capital, subject to regulatory conditions.

17. Disclosure Obligations

Spanish banks must provide sufficient information for users to understand:

• ECL methodologies.
• Definitions of default.
• SICR indicators.
• Stage transfers.
• Macroeconomic scenarios.
• Scenario weightings.
• Changes in assumptions.
• Reconciliations of loss allowances.
• Write-offs and recoveries.
• Modifications and forbearance.
• Collateral.
• Model changes.
• Management overlays.
• Credit-risk concentrations.

Boilerplate disclosure is insufficient where material judgment affects the financial statements.

Relevant Case Laws

Direct judicial interpretation of the mathematical IFRS 9 ECL model remains limited. Many disputes are resolved through accounting supervision, auditing or prudential review rather than ordinary litigation. The following judgments are nevertheless important because they address IFRS 9 classification, loan-loss valuation, bank accounting, resolution valuations or reliance on financial statements.

1. Banco Popular Resolution Valuation Litigation

General Court, judgment of 22 November 2023

Investors challenged aspects of the valuation used in the resolution of Banco Popular Español. Arguments included whether the valuer had interpreted IFRS 9 Stage 3 classification too restrictively and whether expected losses on the bank’s loan portfolio had been properly measured.

The Court examined the valuation methodology in the special context of bank resolution rather than conducting an ordinary IFRS audit.

Importance: IFRS 9 classifications can materially influence the valuation of a failing bank. However, an accounting going-concern valuation and a resolution valuation do not necessarily have identical objectives or assumptions.

2. Aeris Invest Sàrl v European Commission and Single Resolution Board

General Court, Case T-628/17, judgment of 1 June 2022

The case concerned the resolution of Banco Popular. The applicant challenged the resolution decision and the valuations supporting it.

The Court emphasised the exceptional circumstances surrounding a resolution valuation, including urgency and uncertainty. It accepted that provisional information and prudent assumptions may be used where a complete accounting valuation cannot be prepared in time.

Importance: ECL figures and accounting provisions are important inputs, but they are not automatically decisive in determining the resolution value of a Spanish bank.

3. Fundación Tatiana Pérez de Guzmán el Bueno and SFL v Single Resolution Board

General Court, Case T-481/17, judgment of 1 June 2022

Former investors challenged the Banco Popular resolution scheme, including the assessment of the bank’s financial position and the valuation process.

The Court examined the distinction between:

• Solvency.
• Liquidity.
• Accounting position.
• Resolution valuation.
• Failing-or-likely-to-fail status.

Importance: A bank may experience a resolution-triggering liquidity crisis even where debates remain about accounting provisions and asset values. IFRS 9 impairment is therefore important but is not the sole legal test for resolution.

4. Del Valle Ruíz and Others v European Commission and Single Resolution Board

General Court, Joined Cases T-510/17 and related proceedings, judgment of 1 June 2022

Shareholders and creditors challenged the Banco Popular resolution and the underlying valuations.

The Court considered whether the EU authorities had committed manifest errors in assessing the bank’s position. It recognised the broad technical judgment involved in complex financial valuation.

Importance: Courts generally review complex loan-loss and valuation judgments for legality, procedural fairness and manifest error. They normally do not replace the expert’s entire financial model with their own calculation.

5. Banco Santander SA v JC

CJEU, Case C-410/20, judgment of 5 May 2022

The case concerned claims connected with shares in Banco Popular following its resolution and acquisition by Banco Santander.

The Court held that the consequences of resolution law could prevent certain former shareholders from pursuing actions that would undermine the write-down and cancellation of their instruments.

Importance: Alleged errors in accounts, valuations or provisioning may intersect with the special legal effects of bank resolution. Investor remedies that might exist under ordinary securities law can be restricted after resolution to protect the effectiveness of the EU resolution framework.

6. Algebris (UK) Ltd and Anchorage Capital Group LLC v European Commission

General Court, Case T-570/17, judgment of 6 July 2022

This case concerned the restructuring and precautionary recapitalisation of Banca Monte dei Paschi di Siena. The assessment included expected losses, exposure-at-default estimates, probability-of-default information and capital needs.

Although the case concerned an Italian bank, it is relevant throughout the Banking Union, including Spain.

Importance: Expected-loss calculations can directly affect capital assessments, restructuring measures and state-aid decisions. Courts recognise that such assessments involve complex economic evaluations but still require rational and adequately supported methodology.

7. Gutiérrez Naranjo and Others v Cajasur Banco and Other Spanish Banks

CJEU, Joined Cases C-154/15, C-307/15 and C-308/15, judgment of 21 December 2016

The case concerned unfair mortgage floor clauses and repayment of amounts improperly charged to consumers.

It did not interpret IFRS 9 directly. However, the judgment created potentially substantial repayment obligations for Spanish banks.

Importance: Legal developments can change the expected cash flows of loan portfolios and create provisions or contingent liabilities. IFRS 9 models must be coordinated with legal-risk assessments, although consumer redress provisions may fall under IAS 37 rather than IFRS 9.

8. Spanish Supreme Court Bankia IPO Judgments

Supreme Court Judgments 23/2016 and 24/2016, 3 February 2016

Investors purchased Bankia shares on the basis of information provided in the public offering documentation. Bankia later reformulated its accounts, showing a materially different financial position.

The Supreme Court held that serious inaccuracies in the financial information could invalidate the investors’ consent.

Importance: Banks’ financial statements must present a reliable picture of asset quality, impairments and losses. Materially inadequate provisioning can affect investor decisions and lead to civil liability, even though these judgments predated the full application of IFRS 9.

9. Landeskreditbank Baden-Württemberg v ECB

CJEU, Case C-450/17 P, judgment of 8 May 2019

The case concerned the allocation of supervisory responsibility within the Single Supervisory Mechanism.

The Court confirmed the ECB’s central supervisory role within the integrated system, even where national authorities conduct aspects of day-to-day supervision.

Importance for Spain: IFRS 9 implementation by Spanish banks operates within the broader ECB supervisory structure. The ECB can evaluate provisioning practices, credit classification and model governance as part of prudential supervision.

10. Crédit Mutuel Arkéa v European Central Bank

General Court, Cases concerning ECB prudential supervision

These proceedings addressed the ECB’s supervisory powers concerning banking groups, prudential requirements and consolidated risk assessment.

Importance: The cases demonstrate the breadth of supervisory judgment in banking matters. For Spanish banks, weaknesses in IFRS 9 systems may lead not only to accounting corrections but also to prudential supervisory consequences.

18. Practical Example

A Spanish bank granted a €500,000 commercial-property loan in 2021.

At origination:

• One-year PD: 1%.
• LGD: 25%.
• EAD: €500,000.
• The loan is classified in Stage 1.

Simplified 12-month ECL:

500,000×1%×25%=€1,250500,000 \times 1\% \times 25\% = €1,250

Later:

• The borrower’s revenue declines.
• Interest coverage weakens.
• Property value falls.
• The internal rating deteriorates.
• The loan remains contractually current.

The bank concludes that credit risk has increased significantly and transfers the loan to Stage 2.

Assume:

• Lifetime PD: 20%.
• LGD: 35%.
• Expected EAD: €480,000.

Simplified lifetime ECL:

480,000×20%×35%=€33,600480,000 \times 20\% \times 35\% = €33,600

The allowance therefore rises from approximately €1,250 to €33,600 even though the borrower has not yet missed a payment. This illustrates the forward-looking nature of IFRS 9.

19. Main Legal Risks for Spanish Banks

Spanish banks may face legal or supervisory consequences where they:

• Delay transfers from Stage 1 to Stage 2.
• Use unrealistic macroeconomic forecasts.
• Depend excessively on collateral.
• Apply an overly narrow definition of default.
• Automatically return restructured loans to Stage 1.
• Use unsupported management overlays.
• Manipulate stage classification to protect profits.
• Fail to validate models independently.
• Maintain poor-quality historical data.
• Provide insufficient disclosures.
• Underestimate recovery periods and enforcement costs.
• Fail to connect accounting models with credit-risk management.

Consequences may include:

• Restatement of financial statements.
• Qualified audit opinions.
• Banco de España or ECB corrective measures.
• Additional capital requirements.
• Administrative sanctions.
• Investor litigation.
• Director liability.
• Market-disclosure liability.
• Resolution-related valuation disputes.

Conclusion

The IFRS 9 Expected Credit Loss model requires Spanish banks to recognise credit losses before default occurs. Its central mechanism is the division of exposures into three stages:

• Stage 1: 12-month ECL.
• Stage 2: lifetime ECL following a significant increase in credit risk.
• Stage 3: lifetime ECL for credit-impaired assets.

Spanish banks must combine IFRS 9 with Banco de España Circular 4/2017, EBA guidance, ECB supervision and prudential-capital rules. The calculation requires reliable data, forward-looking scenarios, realistic collateral valuations, independent model validation and strong management oversight.

Reported case law directly interpreting IFRS 9 remains relatively limited. Nevertheless, the Banco Popular, Bankia and Banking Union cases show that credit-loss estimates can materially affect financial reporting, investor protection, regulatory capital, state aid and bank resolution. Courts normally give specialised authorities room to make complex financial judgments, but those judgments must remain properly reasoned, evidence-based and legally defensible.