Banking & Market Risk8 min read

IFRS 9 ECL Overlays: Discipline Beyond the Model

By Jonas Adam Mohamed Osman, known as Yonas Osman

CEO of Quantica Risk

60 Rue François Ier, 75008 Paris, France

Published 15 October 2026

Why post-model overlays remain essential under IFRS 9, how auditors and supervisors scrutinise them, and how to govern them without abuse.

Executive answer

IFRS 9 expected credit loss models, built and calibrated on historical data, routinely lag fast-moving macroeconomic shocks — the pandemic, the 2022 energy price spike, and localised commercial real estate stress have all exposed this gap. Management overlays, temporary adjustments applied on top of model output, have become a near-permanent feature of provisioning rather than an exceptional tool, and banking supervisors now expect robust governance around them rather than ad hoc board approval.

The core tension is that overlays exist precisely because models cannot capture novel risks in real time, yet unchecked overlay use undermines the auditability and comparability that IFRS 9 was meant to deliver. Banks that document overlay rationale, size, and expected unwind timing clearly tend to face far less auditor and supervisory pushback than those treating overlays as a black box adjustment.

When overlays are justified versus when they signal model failure

A well-governed overlay addresses a specific, identifiable gap — for example, a sector shock not yet reflected in historical default data, or a forward-looking macroeconomic scenario that model recalibration has not yet absorbed. Overlays of this kind are temporary by construction and should shrink as the underlying model is recalibrated or retrained on data that includes the shock. Persistent, growing overlays covering the same risk driver quarter after quarter are a signal that the underlying model itself needs structural revision, not another layer of management judgment.

External auditors, under International Standards on Auditing, and prudential supervisors including the ECB's targeted reviews of internal models, increasingly ask banks to distinguish these two cases explicitly in disclosures. Banks unable to show a credible unwind path for a long-standing overlay face a higher likelihood of being asked to rebuild the base model rather than continuing to patch it.

Governance expectations from supervisors and auditors

Good practice, reflected in EBA guidance and accounting firm methodology, treats overlays as subject to the same model risk governance as the underlying ECL model: a documented rationale, a quantified sizing methodology, independent challenge, and a defined trigger for removal. Overlays approved verbally or sized by expert judgment alone, without a reproducible calculation, are a recurring audit finding and increasingly a point of supervisory criticism in IFRS 9 thematic reviews.

Boards and audit committees should receive a standing overlay inventory each reporting period, showing each overlay's original rationale, current size, trend versus prior periods, and planned removal date, rather than aggregated commentary. This level of transparency also helps distinguish genuine forward-looking prudence from provisioning smoothing, a distinction that has drawn scrutiny from securities regulators concerned about earnings management through the overlay mechanism.

Macroeconomic scenario design and overlay interaction

IFRS 9's probability-weighted multiple scenario requirement already embeds forward-looking macroeconomic judgment into the base model, which means overlays should not duplicate scenario effects the base model already captures. Banks need a clear mapping between what their macroeconomic scenarios already price in and what the overlay is additionally addressing, otherwise double-counting or, conversely, gaps between scenario and overlay coverage can distort total provisions in either direction.

This is particularly relevant for commercial real estate and leveraged lending portfolios, where base models trained on pre-2022 data may understate refinancing risk under higher-for-longer rates; overlays here need to be reconciled against the scenario narrative used in the base ECL calculation to avoid inconsistent risk messaging to the market and to supervisors.

Conclusion

Overlays are not a flaw in IFRS 9 but a necessary release valve for a standard that requires forward-looking estimates from inherently backward-looking models; the discipline banks apply to governing them is now as important to credit risk credibility as the models themselves. Supervisors and auditors are converging on the same expectation: overlays must be temporary, sized transparently, and replaced by model recalibration as soon as the underlying driver is understood.

Jonas Adam Mohamed Osman, known as Yonas Osman, CEO of Quantica Risk, advises credit risk teams to treat every overlay as an open item with an expiry date, which keeps provisioning both forward-looking and defensible under audit.

Primary sources

IFRS 9expected credit lossoverlaysprovisioningcredit risk