FRANKFURT European Central Bank supervisors are often too lenient with banks in how they manage credit risk, especially in the case of the worst performers, the European Court of Auditors (ECA) said on Friday in a report that highlighted a number of shortcomings.

The ECB supervises just over a hundred of the euro zone's biggest banks and has long complained that lenders are not taking the risk of soured debt seriously, failing to recognise problems or set aside provisions.

But Friday's report from the European Union's external auditor suggests the problem is more systemic than a lack of compliance by banks.

The report concludes that the ECB applies its rules inconsistently, exercises leniency towards the highest-risk lenders, takes too long to make capital decisions, and does not always have adequate supervisory staff.

"The ECB did not impose proportionally higher (capital) requirements when banks faced higher risks, meaning that risks are not clearly linked to the requirement imposed," the ECA said.

"For the highest-risk banks, it consistently selected requirements at the bottom of the pre-defined ranges," the report said, adding that it saw a pattern of the ECB failing to sufficiently escalate supervisory measures when credit risk was high and sustained.

A result of this practice is that a lower-risk bank could actually have higher capital requirements than a higher-risk lender, the ECA said.

The report is the first since the ECB agreed in 2019 to share sensitive bank-specific data for auditing purposes, but its recommendations are non binding.

Responding in the annex of the report, the ECB mostly defended its practices but acknowledged some issues.

"The ECB is of the view that its current methodology for determining additional capital requirements ensures that all material risks to which an institution is exposed are appropriately covered," it said.

Non-performing loans have been on a steady decline for years and stand near an all-time-low, partly because of an aggressive ECB drive to free the bank sector from a historical burden.

Still, the report added that the methodology the ECB has used since 2021 to determine additional capital requirements did not provide assurance that lenders' various individual risks were appropriately covered.

The ECB also takes too long to issue its final capital requirement decisions, such that risks are not always managed in a timely way, the report found.

Another issue was staffing constraints.

The ECB has decided not to increase headcount from 2023 and nine out of 22 national supervisors fall short when it comes to staffing joint supervisory teams, the report said.

(Reporting by Balazs Koranyi; Editing by Christina Fincher)