ECB Sets Deadline for Banks to Meet Its Climate Risk Expectations

The thematic review of the strategies and governance and risk management frameworks covered 107 significant banks under the direct supervision of ECB and 79 less significant banks supervised by their national authorities. ECB conducted this thematic review alongside its supervisory stress test on climate-related risks. In addition, a targeted review of commercial real estate drilled down into climate-related risks in commercial real estate portfolios. In 2022, ECB also checked banks’ management of climate-related and environmental risks through on-site inspections. It also completed a gap analysis of banks’ disclosures of climate-related and environmental risks. The thematic review aimed to check whether banks adequately identify and manage climate risks as well as environmental risks such as biodiversity loss. It also delved into banks’ risk strategies and their governance and risk management processes. The review concluded that, even if 85% of banks now have in place at least basic practices in most areas, they are still lacking more sophisticated methodologies and granular information on climate and environmental risks. There is also supervisory concern related to the execution capabilities of most banks, where effective implementation of their practices is still lagging behind. As a result, banks continue to significantly underestimate the breadth and magnitude of such risks, and almost all banks (96%) have blind spots in identifying them.

The report on good practices follows on from the thematic review of ECB and outlines a set of 26 good practices originating from a range of institutions across various business models and sizes to meet the supervisory expectations set out in the 2020 ECB guide. The report covers observed practices related to strategy-setting, governance, risk appetite, and risk management. ECB also emphasizes the evolving nature of good practices and expects these to mature over time. This report should be read in conjunction with the ECB Guide and the prudential requirements set out in the regulatory framework and, more particularly, the Capital Requirements Regulation Directive, as further specified in the European Banking Authority guidelines.

ECB also outlined the key timelines and steps for banks to achieve full alignment with its expectations by the end of 2024:

• In a first step, ECB expects banks to adequately categorize climate and environmental risks and to conduct a full assessment of their impact on the bank activities by March 2023 at the latest.
• In a second step, and at the latest by the end of 2023, ECB expects banks to include climate and environmental risks in their governance, strategy and risk management. Some banks have already started to plan for the transition to a low-carbon economy and to engage with their clients. However, a wait-and-see approach still prevails in most banks. For example, banks do not set interim targets or limits to their risk-taking with a view to fulfilling their long-term strategic commitments, or set them in such a way that the immediate impact on the bank’s business is negligible.
• In a final step, by the end of 2024, banks are expected to meet all remaining supervisory expectations on climate and environmental risks outlined in 2020, including full integration in the Internal Capital Adequacy Assessment Process (ICAAP) and stress testing.

The deadlines will be closely monitored and, if necessary, enforcement action will be taken. Supervisors are already including bank-specific climate and environmental findings in the Supervisory Review and Evaluation Process (SREP). ECB has imposed binding qualitative requirements on more than 30 banks in its annual SREP. Moreover, for a small number of banks, the outcome of the 2022 supervisory exercises on climate and environmental risks had an impact on their SREP scores. These, in turn, impact their Pillar 2 capital requirements.

Related Links

• ECB Press Release
• Good Practices for Climate Risk Management (PDF)
• Results of Thematic Review on Climate Risk (PDF)

Keywords: Europe, EU, Banking, ESG, Climate Change Risk, Stress Testing, SREP, Basel, Pillar 2, CRR, ICAAP, ECB