Fostering banks’ preparedness for the green transition
Contribution by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, for Eurofi Magazine
Stockholm, 26 April 2023
In a previous contribution for this magazine, I outlined the many efforts made by the ECB in recent years to include climate-related and environmental (C&E) risks as part of its ongoing supervision. I would now like to take stock of the work that we have done in recent months to foster banks’ preparedness for the green transition, and to outline the main deliverables we expect on this front going forward.
The conclusion of our thematic review on C&E risks has been a key milestone in this regard, because it has allowed our supervisors to assess the extent to which banks adequately identify and manage climate risks as well as environmental risks such as biodiversity loss. The review, the results of which were published in November 2022, also looked into banks’ risk strategies and their governance and risk management processes in the C&E domain.
Overall, the results have been mixed. On the plus side, banks have made meaningful progress in accounting for and addressing C&E risks, acknowledging the materiality of such risks in their portfolios and making progress in building up their risk management frameworks and processes. However, the results also showed that, although the bulk of our supervised banks have in place at least basic practices in most areas, they still lack more sophisticated methodologies and granular information on C&E risks. This aspect is critical if banks are to get a firm grip on the C&E risks they actually face. The review concluded that banks therefore continue to significantly underestimate the breadth and magnitude of C&E risks and noted that almost all banks have blind spots in identifying these risks, including in physical risks related to climate change and the management of broader environmental risks beyond climate. Moreover, we also found that banks have yet to address C&E risks in a sufficiently strategic manner, with management boards rarely initiating actions that result in changes to either the strategic direction or to meaningful risk limits.
In its role as prudential supervisor, the ECB has made it clear that it is not in the business of telling banks how green their lending policies ought to be. However, it has also underlined that failing to take into account the transition towards a more sustainable economy would be incompatible with sound risk management. This is why we are insisting that the banks under our supervision manage C&E risks in the future in the same way as they would now manage any other material risk.
With this goal in mind, the ECB has now set bank-specific deadlines for achieving full alignment with its supervisory expectations in the C&E domain, as laid out in the Guide it published in 2020. We are mindful that, important as it may be, this process can also be challenging for banks, which is why we have set staggered deadlines. We expect banks to already have in place an adequate categorisation of C&E risks and to have conducted a full assessment of their impact on their activities, in line with our deadline for the end of March 2023. Looking ahead, we expect banks to include C&E risks in their governance, strategy and risk management by the end of 2023, and to meet all remaining supervisory expectations on C&E risks by the end of 2024, respectively.
Moreover, in order to facilitate the supervisory convergence process, we have published a compendium of good practices among banks derived from our thematic review, for example as regards the integration of C&E risks into the work of the management body or the use of planning tools aimed at managing the risks of the transition, respectively. This compendium should not be seen as a “one-size-fits-all” path towards meeting of our supervisory expectations in the management of C&E risks, but rather as a demonstration of the practical way in which some banks have tackled implementation challenges in order to achieve rapid progress in certain areas.
See “Climate risks for banks – the supervisory perspective”, article by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, for Eurofi Magazine, 7 September 2022.
See “Walking the talk: Banks gearing up to manage risks from climate change and environmental degradation. Results of the 2022 thematic review on climate-related and environmental risks”, ECB, November 2022.
See “Urgent and vitally important: 2023 as a key milestone in stepping up the management of climate and environmental risks”, speech by Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, at the Foreign Bankers’ Association (FBA) 30th anniversary, 27 March 2023.
See “Guide on climate-related and environmental risks: supervisory expectations relating to risk management and disclosure”, ECB, November 2020.
See “Good practices for climate related and environmental risk management: observations from the 2022 thematic review”, ECB, November 2022.