Climate risks for banks – the supervisory perspective
Article by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, for Eurofi Magazine
Prague, 7 September 2022
Climate change poses an increasing risk for banks and the European financial system as a whole. From a prudential perspective, supervisors should be concerned about the extent to which banks’ exposures to physical and transition risks stemming from climate-related and environmental risks (C&E risks) may affect the safety and soundness of individual entities. Such risks, which could potentially affect banks regardless of their size, complexity or business model, could also act as drivers of “traditional” risk categories such as credit, market and operational risk.
In recent years, ECB Banking Supervision has taken concrete steps to include C&E risks in its ongoing supervision. In 2020 we published a guide outlining our expectations for banks’ management and disclosure of such risks. In 2021 we asked banks to conduct a self-assessment in the light of the supervisory expectations outlined in the guide and to draw up implementation plans to advance their management of C&E risks. We have since conducted annual reviews to check progress on these action plans as well as on banks’ transparent disclosure of their C&E risk profiles. In 2022 we conducted a climate risk stress test to more fully understand how exposed euro area banks are to C&E risks, the results of which were published in July. We are also preparing a thematic review on C&E risks to assess where banks stand in terms of their alignment with the ECB’s supervisory expectations in this domain, which will be published later this year.
The common message which emerges from these various initiatives on the supervisory front is that while banks are making progress in their management of C&E risks, this trend is not uniform and laggards remain in all areas. The preliminary results from our thematic review suggest that, according to their own assessment, an increasing number of banks report that they are taking actions to foster alignment with our supervisory expectations. This is an improvement on the 90% of banks which considered that their practices were only partly or not at all aligned with our expectations in 2021. However, our results also indicate that while a growing number of banks have deemed themselves to be materially exposed to C&E risks in the short to medium term, there are some that have still not performed a materiality assessment. Concerning banks’ disclosure of their C&E risks, the gap analysis in the 2022 ECB report indicated that they have made clear progress in various areas compared with 2021, for example as regards governance and risk management. However, the report also highlighted that most banks still need to make significant efforts to transparently disclose their exposures to C&E risks and further improve their disclosure practices. With regard to the stress test on climate risk, the results showed that around 60% of banks do not have robust climate risk stress-testing frameworks, with many lacking accurate data and insights into their clients’ transition plans. Similarly, the results showed that most banks do not include climate risk in their credit risk models and just 20% consider climate risk as a variable when granting loans.
At the same time, the experience from our broad engagement with banks concerning their management of C&E risks in recent years suggests that they are cognisant of the challenge at hand. Some have already adopted state-of-the-art governance and risk management practices and, in more than 80% of cases, they intend to complete the actions set out in their plans before the end of 2023. We thus see it as reasonable that banks can be fully compliant with all our expectations by the end of 2024 at the latest. Our goal is to fully integrate C&E risks in the regular supervisory cycle and treat them in the same way as any other material risks that banks face, eventually influencing their Pillar 2 requirements.
ECB Banking Supervision (2020), “Guide on climate-related and environmental risks”, November.
ECB Banking Supervision (2021), “The state of climate and environmental risk management in the banking sector”, November.
ECB Banking Supervision (2022), “Thematic review on climate-related and environmental risks, 2022”, presentation by the SSM Climate Risk Coordination Group, 18 February.
ECB Banking Supervision (2022), “Supervisory assessment of institutions’ climate-related and environmental risks disclosures”, March.
ECB Banking Supervision (2022), “2022 climate risk stress test”, July.