Intended to streamline council payments and HR systems, the flagship system was expected to cost £19m. But after three years of delays, it was revealed in May it could cost up to £100m.
On Tuesday evening, the government's Department for Levelling Up, Housing and Communities (DLUHC) said it had been "engaging regularly" with the council in recent months over the "pressures it faces", and had "expressed serious concern over its governance arrangements".
"We have requested written assurances from the leader of the council that any decision regarding the council's issues over equal pay represents the best value for taxpayers' money," it added.
Mr Cotton, who is not currently in the city due to "long standing family commitments", insisted to BBC Radio WM the council would "continue to deliver on essential services like children's safeguarding and social care, social care for adults, education, waste collection, road maintenance and library services" for the city's 1.1 million taxpayers.
The leader claimed he had only learned of the financial crisis at the same time as other councillors during Tuesday morning's cabinet meeting.
The council has declared a Section 114 notice, previously issued by other councils including Croydon and Thurrock, which means a local authority has judged itself to be in financial distress and can no longer balance its budget.
In a statement issued earlier, he and the deputy leader of the Labour authority, Sharon Thompson, said the move was a "necessary step as we seek to get our city back on a sound financial footing".
Ms Thompson said the council would "do everything we can to protect the services our residents rely on".
But taxpayers have spoken of their fears at where the axe may fall as the council halts all but essential spending.
Kynton Swingle, from the Fox Hollies Community Association in Acocks Green, said it could mean groups such as theirs were unable to continue key services.The organisation offers a range of support including free meals for youngsters and as a warm hub for people struggling to heat their homes.The financial freeze would mean a "really challenging environment" and "there is definitely concern", Mr Swingle added.
Posting on X, formerly Twitter, Maria Smith described the news as "horrendous" and said the impact of it was "going to be immense".
"My father was waiting for a lift to be installed under a grant. I don't know if this is going to happen now. Oh god, this is awful," she added.
Mr Cotton and Ms Thompson said it was "clear that Birmingham City Council faces unprecedented financial challenges, from huge increases in adult social care demand and dramatic reductions in business rates income, to the impact of rampant inflation".
"We implemented rigorous spending controls in July, and we have made a request to the Local Government Association for additional strategic support."
The Section 114 was crucial to be able to "build a stronger city for our residents", they added, promising to protect the "most vulnerable".