The management of climate-related and environmental risks in the banking sector through the lens of supervision
Introductory remarks by Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, at a virtual meeting hosted by the European Financial Services Round Table to discuss climate-related and environmental financial risks
Frankfurt am Main, 20 January 2023
Many thanks to the European Financial Services Round Table (EFR) for hosting this session on the state of play of managing climate-related and environmental risks, or C&E risks for short, in the financial sector. As the EFR recognised early on, in a statement released in 2015 just before the adoption of the Paris Agreement, the financial sector has a key role to play in understanding and managing these risks. Today in my introduction, I want to describe the progress that we in ECB Banking Supervision have observed in recent years, through the lens of our interactions and exercises with the banks we supervise.
Back in 2020 we published our Guide on C&E risks for banks. The Guide demonstrated the ECB’s commitment – within its mandate – to making the financial system more resilient to these risks. In the Guide, we set out 13 supervisory expectations for how the banks under our direct supervision should integrate C&E risks into their business models and strategies, governance and risk appetite. In doing so, we were very much moving in lockstep with the global principles for supervising C&E risks. At first, this represented an informal global consensus, building on the prevailing best practices identified by the global Central Banks’ and Supervisors’ Network for Greening the Financial System (NGFS). By now, however, there is a concrete formal global consensus, enshrined in the principles for the effective management and supervision of these risks, which the Basel Committee on Banking Supervision adopted and published in June 2022.
As a follow-up to our own Guide, in 2021 we published the findings of a benchmarking exercise in which we thoroughly reviewed the practices and plans of the largest banks in the euro area across more than 130 focus areas. We conducted this exercise based on the banks’ own assessments of their performance against our supervisory expectations. Covering 112 directly supervised banks, with combined assets of €24 trillion, the exercise was an unprecedented stocktake of European banks’ preparedness to adequately manage and disclose their exposure to C&E risks. Banks were indeed very open and candid in these self-assessments, for which we as supervisors were very grateful. The results showed that while most banks acknowledged that C&E are material for their risk profile within three to five years, almost all banks were only partially or not at all aligned with our supervisory expectations.
Against the backdrop of this relatively poor performance by the banks, almost one year ago I announced that 2022 would be the year in which we would move to what I called an immersive supervisory approach to C&E risks. The year in which these risks become fully integrated in the day-to-day activities of our joint supervisory teams, who are in constant contact with banks. And the year as of which C&E risks come to form an integral part both of our ongoing dialogue with supervised banks, and of the supervisory review and evaluation process, or SREP. This is an encompassing and integrated approach, which supervisors and banks are already very familiar with for traditional risk categories. It is an approach that is here to stay. And its objective is to ensure banks fully account for and manage C&E risks, as they would any other material risk.
To support this effort we conducted several supervisory exercises, including a climate stress test, a thematic review of C&E risks, onsite inspections and a targeted review of commercial real estate exposures.
When discussing the results of these exercises in 2022, I observed that we see the glass filling up slowly, but it is not yet even half full. Yes, the climate and environmental crises have made it to the top levels within banks and some first steps have been taken. But there is a difference between talking about steps and beginning to act; and there is an even bigger difference in doing what is needed.
For example, in the climate stress test we found that three in five banks still do not have a climate stress test framework in place. Although the large majority of the banks with a climate risk stress-testing framework in place have developed a validation process, most of them do not ensure independence between the development and validation processes. Only one in five banks consider climate risks when granting loans. Only one in four banks include liability and reputational risks when assessing climate risks. And most banks rely heavily on proxy data to quantify their customers’ emissions, with on aggregate half of banks’ income currently coming from heavy greenhouse gas emitters. Such reliance on high emitters might be profitable today, but it won’t be tomorrow. And as the thematic review showed, even though banks are starting to manage these risks by putting the basic infrastructure in place, they still have a long way to go to be truly resilient to the climate and environmental crises. For example, they lack granular information on these risks, and their methodologies for assessing their risk exposures remain relatively unsophisticated. When assessing climate-related credit risks many banks look at sectoral exposures, whereas risk differentials are better identified at a more disaggregated level. And as supervisors, we are concerned about banks’ ability to effectively implement their plans in practice.
Against this backdrop, we will continue to scale up our supervisory activities on C&E risks. We expect banks not only to be able to manage these risks in full by the end of 2024 at the latest, but to actually be doing so. This means that by then they will need to be in full compliance with all the supervisory expectations we set out in 2020. We have also set interim deadlines for them to reach specific milestones, and have shared the good practices among banks derived from our thematic review. At the same time, we have made banks aware of the supervisory consequences they will face if they fail to meet their C&E risk management responsibilities. Deadlines will be closely monitored and, if necessary, enforcement action will be taken.
Let me conclude my introduction by emphasising that there are silver linings to all our exercises. We consistently make an effort to identify and share with banks the good practices that we observe. Both the stress test and the thematic review come with separate, dedicated good practices reports. It is these good practices that give us confidence that what we are asking from all banks is feasible by the end of 2024. That being said, the good practices identified should not be seen as a “one size fits all” roadmap to compliance with our supervisory expectations. We expect the good practices we currently see to also further evolve in the future as the climate and environmental crises evolve and the green transition gains traction. And, ultimately, every bank needs to find its own way, and push its own boundaries, to manage its C&E risk exposures according to its own specific circumstances and business model needs.
Thank you for your attention. I look forward to our exchange of views.
European Financial Services Round Table (2015), “EFR Statement in support of a strong, ambitious response to climate change”, November.
ECB Banking Supervision (2020),“Guide on climate-related and environmental risks: Supervisory expectations relating to risk management and disclosure”, November.
Basel Committee on Banking Supervision (2022), “Principles for the effective management and supervision of climate-related financial risks”, June.
Elderson, F. (2022), “Towards an immersive supervisory approach to the management of climate-related and environmental risks in the banking sector”, speech at an industry outreach event, Frankfurt am Main, 18 February.
ECB Banking Supervision (2022), “Good practices for climate-related and environmental risk management – observations from the 2022 thematic review”, November; and ECB Banking Supervision (2022), “2022 climate risk stress test”, July.