ECB sanctions BIL for breaching ECB decision on internal models

What Changed

• - The ECB has reaffirmed that institutions using internal ratings-based (IRB) approaches must apply their approved internal models consistently for expected loss calculation on defaulted retail and corporate exposures, without unilateral deviations o
• The ECB has underscored that the IRB shortfall (difference between expected loss and accounting provisions) must be correctly calculated and deducted from regulatory capital whenever expected loss exceeds provisions, ensuring capital adequacy reflect
• The ECB has classified intentional failure to apply approved internal models to expected loss calculations as a “severe” breach under its Guide to the method of setting administrative pecuniary penalties, signalling a higher sanctions range for simil
• The enforcement action confirms the ECB’s readiness to use its sanctioning powers under Article 18 of Council Regulation (EU) No 1024/2013 against internal-model users that misreport capital due to model misuse or non-application.
• The case highlights that miscalculation of expected loss and IRB shortfall over multiple reporting periods, even without an explicit capital ratio breach of minima, can be sanctioned where capital ratios are overstated relative to the true risk posit
• Institutions are reminded that ECB sanction decisions can be challenged before the Court of Justice of the European Union under Article 263 TFEU, but remain binding unless annulled, making robust governance around internal models essential.

Suggested Considerations

• Review and confirm that all regulatory capital calculations, including expected loss and IRB shortfall for defaulted exposures, consistently use the approved internal models as authorised by the ECB or national competent authority.
• Map and reconcile the internal-model implementation across risk systems, finance, and regulatory reporting to ensure that there are no manual overrides, alternative methods, or parallel calculations that deviate from the approved model specifications.
• Strengthen model risk governance by ensuring that any proposed changes to expected loss methodologies, including for defaulted retail and corporate portfolios, are formally approved by the competent authority before being used in regulatory capital reporting.
• Implement robust controls and periodic testing within Finance, Risk, and Regulatory Reporting functions to detect and prevent misapplication or non-application of approved internal models, with clear escalation procedures for identified discrepancies.
• Ensure that the calculation of IRB shortfall (difference between expected loss and accounting provisions) is independently validated and appropriately deducted from CET1 capital in accordance with CRR and ECB internal models guidance.
• Update internal policies, procedures, and model documentation to explicitly prohibit intentional non-use of approved internal models in favour of alternative calculations for expected loss or capital where such changes have not been authorised.

Key Dates

Who is Affected