knowledge 23 August 2021 |

ECB Urges Banks to Take Swifter Action on Climate and Environmental Risks

By way of background, the ECB’s ‘Guide on climate-related and environmental risks’¹, which was published in November 2020, outlined 13 supervisory expectations relating to risk management and disclosure and banks were asked to assess themselves against these expectations and to submit action plans to the ECB for evaluation.

The newsletter, entitled ‘The clock is ticking for banks to manage climate and environmental risks’² sets out some of the preliminary findings of the ECB’s assessments of those plans.

Progress made but still too slow

In summary, the ECB found that although banks have made some progress in adapting their practices, progress was still too slow.

In particular, the ECB found that:

• while banks have started to include climate and environmental risk in the risk inventory, only a handful have set key risk indicators or have concrete risk limits meaning that banks cannot properly control or manage these risks with sound governance and management oversight also potentially being hampered.

• banks have not yet considered climate and environmental risks in all stages of credit-granting and monitoring processes.  While almost half of banks have integrated climate and environmental risks into their lending policies and client due diligence, most are still lacking a sound risk classification structure or loan pricing framework for climate and environmental risks.  This means that those banks are generally not yet in a position to identify, manage and monitor climate and environmental risks at counterparty level.

• although all banks have developed implementation plans in line with the ECB guide, only one third of banks have plans in place that are at least broadly adequate with roughly two-thirds of banks failing to sufficiently tailor their plans to the supervisory expectations with many plans lacking operational details on how their deliverables will actually be produced.  Indeed, the ECB found that “one fifth of those  banks have (somewhat) inadequate plans that suggest that their C&E [climate and environmental] risk practices will improve only slightly, if at all….  In other words, these banks have significant gaps in their current practices but do not have credible plans to ensure sound management of C&E risks in the future.”  According to the ECB, operational risk management, liquidity risk management, reporting and disclosures require the most work.

• less than 35% of banks expect their credit and liquidity risk management practices to be aligned with the supervisory expectations in the near future which is, according to the authors of the newsletter, “rather alarming as banks are crucial to financial stability, so their strategies, risk management and disclosure arrangements need to be sound.”

Next steps

The newsletter also outlines next steps to be taken by the ECB in relation to banks’ practices and implementation plans and more broadly with respect to climate and environmental matters:

• the Joint Supervisory Teams have started to discuss banks’ practices and implementation plans.

• all banks will receive a detailed feedback letter and will be asked to take decisive action to address identified shortcomings.  In some cases, where banks are extreme outliers, the ECB will impose a qualitative supervisory measure as part of the 2021 Supervisory Review and Evaluation Process.

• later this year, the ECB intends to publish a report that sets out more good examples of how banks have effectively developed their practices and plans.

• in addition to the climate risk stress test, ECB Banking Supervision will conduct a full supervisory review in 2022, including an in-depth analysis of the extent to which bnaks have incorporated climate and environmental risks into their strategy and risk frameworks.

• the ECB will also give greater prominence to environmental risk beyond climate related risks, such as risks of biodiversity loss and pollution with banks’ risk management expectated to take a holistic approach to identify, monitor and manage all material climate-related and wide environmental risk drivers.

Conclusion

The authors acknowledge that banks have been candid about their need to improve their performance to meet supervisory expectations.  This report and others such as that published by the European Banking Authority in May which estimated that the aggregated green asset ratio of EU banks stood at 7.9%³, show the work that remains to be done by banks to properly integrate climate and environmental risks into all aspects of their business, from governance arrangements to lending policies.