European Banks don’t pass the ECB’s examination on climate and environmental risk management

The plan

The energy transition with the aim of achieving net zero emissions by 2050 inevitably involves all sectors of economic activity. Among them there is also the financial sector: banks, investment funds and insurance companies. Their role will be decisive in dictating the timing of the transition and can influence the behavior of industrial companies.

On November 2020, ECB published the “Guide on climate-related and environmental risks” in which confirmed that from 2022 climate risks will fully pass the stress tests of European banks. The guide explains how the ECB expects banks to prudently manage and disclose such risks transparently under current prudential rules.  

The current situation

Exactly one year later, on November 2021, after a deep review of banks’ poor approach with environmental challenges, ECB announced the urgent need of all European banks to improve and enhance their business plans to try to avoid facing climate change risks. None of them passes the European Central Bank’s examination of climate and environmental risk management, and only one third has “well-suited” plans.

The former Eurotower released its first large-scale assessment of how European banks are adjusting their practices to manage climate and environmental (C&E) risks, in line with expectations set out in the November 2020 C&E Risk Guide. According to the Authority, banks have taken the first steps to incorporate climate-related risks, but “none are close to meeting all supervisory expectations”.

There is a regularly taken supervision activity on banks which is called the Supervisory Review and Evaluation Process (SREP), it summarizes the findings of a given year and provides “homework” to banks. In this specific case, the SREP shows the way banks deal with any risk they need to face.

This time, the analysis involved 112 banks subject to direct supervision with a total asset of 24 thousand billion euros. Half of the banks assessed expect climate and environmental risks to have a significant impact on the risk profile over the next three to five years: credit, operational and business model risk are the most affected areas. And all the banks that do not consider themselves exposed to climate-related risks have found significant deficiencies in their risk assessment.

«I did not expect banks to make “major improvements” in their climate risk management strategies».  The fundamental concept to understand is that «Banks are mirroring the real economy; the real economy is not sustainable so the way banks operate is not as well sustainable». Said Sasja Beslik, head of sustainability at Denmark’s largest pension fund PFA and a prominent environmental, social and governance investor.

The expected future

Almost all banks have developed plans to improve their practices. However, the quality of these plans is not standard for each bank and the progress is too slow. Only a third of banks have “adequate” plans in place and half will not even have completed the implementation of their plans by the end of 2022.  

On the bright side, the ECB did find some positive aspects. Frank Elderson, vice president of the supervisory board of the ECB, said that there are some encouraging data: two thirds of banks did actually do extra due diligence on borrowers’ climate risks or phasing out lending to some of the most exposed industries, in order to try changing their plan making some meaningful progress towards a more business / clients awareness on climate change.

Since everyone is concerned about this situation, in the first half of 2022 ECB will publish a report on banks’ climate risk disclosures and is planning a broader review on banks’ strategy, governance and risk

European Banks don’t pass the ECB’s examination on climate and environmental risk management

The plan

The energy transition with the aim of achieving net zero emissions by 2050 inevitably involves all sectors of economic activity. Among them there is also the financial sector: banks, investment funds and insurance companies. Their role will be decisive in dictating the timing of the transition and can influence the behavior of industrial companies.

On November 2020, ECB published the “Guide on climate-related and environmental risks” in which confirmed that from 2022 climate risks will fully pass the stress tests of European banks. The guide explains how the ECB expects banks to prudently manage and disclose such risks transparently under current prudential rules.  

The current situation

Exactly one year later, on November 2021, after a deep review of banks’ poor approach with environmental challenges, ECB announced the urgent need of all European banks to improve and enhance their business plans to try to avoid facing climate change risks. None of them passes the European Central Bank’s examination of climate and environmental risk management, and only one third has “well-suited” plans.

The former Eurotower released its first large-scale assessment of how European banks are adjusting their practices to manage climate and environmental (C&E) risks, in line with expectations set out in the November 2020 C&E Risk Guide. According to the Authority, banks have taken the first steps to incorporate climate-related risks, but “none are close to meeting all supervisory expectations”.

There is a regularly taken supervision activity on banks which is called the Supervisory Review and Evaluation Process (SREP), it summarizes the findings of a given year and provides “homework” to banks. In this specific case, the SREP shows the way banks deal with any risk they need to face.

This time, the analysis involved 112 banks subject to direct supervision with a total asset of 24 thousand billion euros. Half of the banks assessed expect climate and environmental risks to have a significant impact on the risk profile over the next three to five years: credit, operational and business model risk are the most affected areas. And all the banks that do not consider themselves exposed to climate-related risks have found significant deficiencies in their risk assessment.

«I did not expect banks to make “major improvements” in their climate risk management strategies».  The fundamental concept to understand is that «Banks are mirroring the real economy; the real economy is not sustainable so the way banks operate is not as well sustainable». Said Sasja Beslik, head of sustainability at Denmark’s largest pension fund PFA and a prominent environmental, social and governance investor.

The expected future

Almost all banks have developed plans to improve their practices. However, the quality of these plans is not standard for each bank and the progress is too slow. Only a third of banks have “adequate” plans in place and half will not even have completed the implementation of their plans by the end of 2022.  

On the bright side, the ECB did find some positive aspects. Frank Elderson, vice president of the supervisory board of the ECB, said that there are some encouraging data: two thirds of banks did actually do extra due diligence on borrowers’ climate risks or phasing out lending to some of the most exposed industries, in order to try changing their plan making some meaningful progress towards a more business / clients awareness on climate change.

Since everyone is concerned about this situation, in the first half of 2022 ECB will publish a report on banks’ climate risk disclosures and is planning a broader review on banks’ strategy, governance and risk management around climate change risk.

Author: Elisabetta Duranti

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