Banking in a changing climate – preparing for what lies ahead

Banking in a changing climate – preparing for what lies ahead

Global warming affects everyone, whether you are a consumer, a saver, an investor, a bank, a supervisor or a regulator. But how does it actually affect the banking sector and what is being done to tackle this challenge?

Climate change creates both “physical” and “transition” risks. Physical risks mean that banks can be affected directly and indirectly, but nonetheless materially, by more frequent and severe extreme weather events. Weather phenomena, among other things, could weaken the business sectors to which banks are exposed (by damaging crops in a field, for example) or destroy collateral holdings. Transition risks result from the adjustment to a lower-carbon economy. This could affect various economic sectors (including the fossil fuel industry, energy-intensive sectors, utilities, and the transport and building sectors). These climate risks require a strategic approach. Banks need to take action to properly manage their exposures to the sectors concerned. These climate-related risks should therefore be accounted for and appropriately dealt with in their risk management frameworks, just like any other risk they face.

Financial policy and regulation need to be aligned and coordinated to tackle climate change risks and ensure sustainable development. At the European level, the European Commission issued an Action Plan on Sustainable Finance in early 2018 to combat the rise in global temperatures. The ECB has been increasingly involved in sustainable finance since it joined the Network for Greening the Financial System (NGFS) in May 2018. This global network of supervisors and central banks aims to mobilise the financial system to manage climate and environment-related risks and scale up green finance to support the transition towards a sustainable economy. In its first comprehensive report, published in April 2019, the NGFS called for collective action and reasserted climate change as a source of financial risk. ECB Banking Supervision also included climate-related risks among the 2019 key risk drivers affecting the euro area banking system.

Supervisors are engaging with banks to raise awareness of climate risks and to understand whether and how climate issues are taken into account in each institution’s risk framework, including in strategy, internal governance, risk management and control, and disclosure. From a risk-management perspective, the lack of clear common definitions and data makes it difficult to measure the impact these risks have on individual banks, let alone compare them. While the ECB has not adopted any supervisory expectations or guidance on climate-related risks to date, it is working with the national competent authorities (NCAs) to share knowledge and experience in this field. In the context of the NGFS, the ECB is contributing to technical documents on climate and environmental risk management for supervisory authorities and financial institutions.

Several more initiatives in this field have been initiated, including by the banking industry itself. In line with the European Commission’s Action Plan, the European Banking Authority has also started to gather more information on environmental, social and governance risks. In addition, a number of NCAs are already exploring ways to address climate-related risks within the existing regulatory framework.

Overall, the global momentum is clearly there: it is in everyone’s interest to fight climate change. Further work will follow and, within their mandate, ECB supervisors are looking forward to playing an active role in the debate and working with banks to prepare for and manage climate risks.

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