Public consultation on the draft ECB Guide on climate-related and environmental risks
Frequently asked questions
What is the purpose of the Guide?
The Guide on climate-related and environmental risks explains how the European Central Bank (ECB) expects banks to safely and prudently manage climate-related and environmental risks and disclose such risks transparently.
Current prudential rules require banks to identify, manage and disclose all material risks to which they are exposed. The ECB wants banks to account for climate-related and environmental risks given that they drive existing prudential risk categories and can have a substantial impact on the real economy and banks. The Guide is intended to raise banks’ awareness of climate-related and environmental risks and to better prepare them for the future.
More specifically, the Guide spells out how the ECB expects banks to account for climate related and environmental risks when they formulate and implement their business strategy, and in their governance and risk management. It also explains how the ECB expects banks to become more transparent and better disclose climate-related and environmental risks.
Is this Guide legally binding?
The Guide is not legally binding. It is a tool that outlines the ECB’s understanding of how banks are expected to safely and prudently manage climate-related and environmental risks under the current prudential framework (the Capital Requirements Regulation, Capital Requirements Directive and European Banking Authority (EBA) Guidelines). Joint Supervisory Teams will discuss these expectations with their banks as part of the supervisory dialogue. Banks are expected to assess whether their current practices are safe and prudent in the light of the expectations and, if necessary, to start adapting them. The ECB will consider any practices that diverge from the expectations on a case-by-case basis.
Who are you asking for feedback and why? What are the next steps?
The ECB is seeking feedback from banks and other stakeholders that it will take into account when finalising its supervisory expectations in its draft Guide. After taking into consideration the feedback received, it will finalise and publish the final Guide. From then on the ECB will use the Guide in its supervisory dialogue with significant banks.
As part of the consultation process, the ECB will organise an Industry Dialogue Webinar on 17 June, as well as a public hearing on 2 September. The dialogue brings together supervisors, policymakers and banks to further exchange views on the subject. Banks directly supervised by the ECB will be invited for the Webinar. However, it should be noted that only formal comments to the Guide submitted through the public consultation webpage will be considered for the consultation. By comparison, the public hearing is intended to answer questions from all stakeholders and is open to any interested party.
How do you define climate-related and environmental risks?
Climate-related and environmental risks are commonly understood to include the following two main risk drivers:
- Physical risks, which refer to the financial impacts of: (i) a changing climate, including more frequent extreme weather events and gradual changes in climate, and (ii) environmental degradation, such as air, water and land pollution, water stress, biodiversity loss and deforestation. These changes can directly result in, for example, damage to property or reduced productivity. Indirectly they can lead to issues such as the disruption of supply chains.
- Transition risks, which refer to financial losses that can result, directly or indirectly, from the process of adjustment towards a lower-carbon and more sustainable economy. These risks can arise owing to, for example, relatively abrupt adoptions of climate and environmental policies, technological progress or changes in market sentiment and preferences.
Physical and transition risks have an impact on economic activities, which in turn affect the financial system. This impact can occur directly through, for example, lower corporate profitability or asset devaluation, or indirectly, through macro-financial changes. In addition, physical and transition risks can trigger further losses stemming directly or indirectly from legal claims on the bank (commonly referred to as “liability risk”) and reputational losses for failing to adequately manage climate-related and environmental risks.
Consequently, physical and transition risks are drivers and potentially aggravating factors of prudential risk categories, in particular credit risk, operational risk, market risk and liquidity risk.
Will the Guide apply only to banks directly supervised by the ECB (significant banks) or will it also apply to the smaller banks under the supervision of the national authorities (less significant banks)?
The ECB and the national competent authorities (NCAs) have jointly developed the Guide with a view to ensuring that high supervisory standards are applied consistently across the euro area.
The ECB will use the expectations set out in the Guide in its supervisory dialogue with significant banks. NCAs are recommended to apply the expectations when supervising less significant banks, in a proportionate manner.
When will the Guide apply?
The Guide will apply as of the final publication date. The ECB will expect significant banks to consider the extent to which their current management and disclosure of climate-related and environmental risks are safe and prudent in the light of the expectations set out in the Guide. Where needed, it will also expect significant banks to promptly start adapting their practices.
However, the ECB acknowledges that banks may need some time to adapt their practices. The methodologies and tools for managing and disclosing climate-related and environmental risks are expected to mature over time.
Does the publication of the Guide address a shortcoming? In other words, does it mean that banks currently don’t manage and disclose climate-related and environmental risks adequately?
The ECB has assessed how euro area banks are addressing climate-related and environmental risks. While noting that banks have become increasingly aware of the potential significance of climate-related risks, the ECB also identified sparse and heterogeneous risk management and disclosure practices. It also found that until now banks have approached the topic predominantly from the perspective of corporate social responsibility and that their approaches vary depending on their size, business model, complexity and geographical location. Most banks have yet to develop a comprehensive and forward-looking risk management approach.
The ECB wants banks to adopt a timely, forward-looking and comprehensive approach towards considering climate-related and environmental risks. It expects to see progress in their risk management and disclosure, and hopes to support this by clarifying supervisory expectations.
How does the Guide interact with NGFS, EBA and national initiatives on sustainable finance? How are all these initiatives aligning their messages to banks?
The ECB and the NCAs have jointly developed the Guide with a view to ensuring that high supervisory standards are applied consistently across the euro area. The Guide takes into account, and to some extent builds on, existing publications by banking supervisors and regulators, especially the NCAs, the EBA and the Network for Greening the Financial System (NGFS).
At the international level, the ECB participates in the work conducted by the NGFS. In April 2019 the NGFS issued recommendations to boost the role of central banks and supervisors in managing climate-related and environmental risks and is currently developing practical guidance on how to implement the recommendations. One of the NGFS recommendations is for supervisors to set supervisory expectations. The ECB Guide is a way of implementing this recommendation.
At the European Union level, ECB Banking Supervision is involved in the work carried out by the EBA, which has been given several mandates to assess how to incorporate environmental, social and governance risks into the three pillars of prudential supervision. In December 2019 the EBA published an Action Plan on sustainable finance containing key policy messages addressed to banks and highlighting the importance of early action before the prudential framework is formally updated. The ECB Guide further articulates these key policy messages.
Furthermore, a number of NCAs have issued, or are in the process of issuing, guidance on climate-related and environmental risks. Less significant banks are expected to consider these as well as other relevant publications by their NCAs.
What else is the ECB doing to deal with climate-related and environmental risks?
The ECB website describes how the ECB is taking action on climate change in its areas of competence. These include economic analysis, banking supervision, monetary policy, investment portfolios and financial stability.
More broadly, the ECB is actively engaging in a dialogue on climate-related and environmental risks with other supervisors and central banking authorities at the international level. Besides being a member of the NGFS, the ECB is also a member of the European Commission’s Technical Expert Group on Sustainable Finance (TEG), which, among other things, has developed a taxonomy of sustainable activities. Furthermore, the ECB actively participates in the work carried out by the EBA and the Basel Committee on Banking Supervision.
As a result of this Guide, will climate-related and environmental risks feature more prominently in future stress tests?
The Guide explains that the ECB expects significant banks to use (stress) scenarios both to assess if climate-related and environmental risks are material with regard to their business strategy and to inform their decisions. Furthermore, the ECB expects institutions with material climate-related and environmental risks to evaluate whether their bank-internal stress testing is appropriate, with a view to incorporating those risks in their baseline and adverse scenarios.
In addition, the ECB is carefully studying the potential impact of climate-related risks on the euro area financial system. The ECB is currently working with the European Systemic Risk Board and EU central banks to finalise a pilot climate risk stress test. Preparatory work is also under way for an ECB macroprudential stress test. The stress test framework aims to assess how climate-related risks move through the real economy and the financial system. The stress test will draw on granular information and focus on 90 significant banks across the euro area.