ECB report finds banks failing to meet climate risk goals
A report from the European Central Bank (ECB) has found that most banks are partially or wholly missing climate risk goals.
The study looks at the state of climate-related and environmental (C&E) risk management in 112 banks under its direct supervision, with €24 trillion of combined assets.
The report is described by Frank Elderson, Member of the Executive Board and vice-chair of the Supervisory Board of the ECB, as “an unprecedented stocktake of European banks’ preparedness to adequately manage and disclose their exposure to C&E risks”.
The State of C&E Risk Management in the Banking Sector has been compiled one year after the ECB published its Guide on C&E risks for banks.
In the Guide, the ECB set out 13 supervisory expectations for the banks regarding the integration of C&E risks into their business models and strategies, governance and risk appetite.
Almost all banks that participated in the one-year survey were found to be only partially – or not at all – aligned with the ECB’s supervisory expectations.
Notably, of the institutions that report C&E risks as being immaterial to them, not a single one was found to have an appropriate materiality assessment in place: they are either not comprehensive enough in their risk assessment or they have not even attempted to analyse the impacts of climate risk on their business at all.
Many of the banks do recognise that C&E risks will have a material impact on their risk profile within the next three to five years, especially in terms of credit, operational and business model risk. And most banks have started to adapt their practices to meet the supervisory expectations.
However, only the practices of a few banks are having a discernible impact on their strategies and risk profiles. So far, banks were found to have made most progress in adapting their governance and policies, while some have started to incorporate C&E risks into their lending policies and to attribute formal responsibilities within their organisation for the management of these risks.
Banks have been placing less emphasis on identifying and measuring these risks through a set of key risk indicators. And fewer than half have taken any steps to adjust their business model and strategic planning in the face of what Elderson calls “inevitably larger climate-related risks going forward”.
Banks have made the least progress in the areas of internal reporting, market and liquidity risk management, and stress testing.
The report does highlight some good practices identified regarding banks’ integration of C&E risks.
Two-thirds of banks have made meaningful progress in integrating climate-related risks into their credit risk management. They have achieved this through measures such as enhanced due diligence procedures or new phasing-out criteria to limit the financing of activities that are highly exposed to climate-related risks.
Banks are also starting to assess energy label certifications when evaluating real estate collateral, although most do not yet include the results in their lending and monitoring practices.
Elderson concludes: “By publishing such an extensive and detailed set of information on the good practices identified across the euro area banking sector, the ECB hopes to close some of the gaps identified thus far and encourage banks to proceed more forcefully towards fully integrating C&E risks into their DNA.”
More widely, to date the majority of banks have no plans for concrete actions to adjust their business strategies. While half of the banks are contemplating setting exclusion targets for some segments of the market, only a handful mention actively planning to steer their portfolios on a Paris-compatible trajectory.
In this context, the European Commission has put forward a proposal – Strategy for Financing the Transition to a Sustainable Economy – for a legally binding requirement for banks to develop, implement and disclose their transition plans.
Such transition plans should highlight banks’ alignment with and potential divergences from the relevant policy objectives through which the EU implements the Paris Agreement at any point between now and 2050.
The ECB has said that if the Commission’s proposal is adopted, the bank will collaborate with other EU agencies to monitor banks’ progress in adapting to an economy that is transitioning to carbon-neutrality in order to avert the build-up of stranded assets on their balance sheets.
The ECB will continue to roll out its supervisory agenda on climate-related and environmental issues.
In 2022 it will conduct a thematic review of institutions’ C&E risk management practices and a supervisory stress test with a view to gradually integrating C&E risks into the Supervisory Review and Evaluation Process (SREP) methodology. Once integrated into the SREP, banks’ exposure to C&E risks will eventually influence their Pillar 2 requirements.