The European Central Bank has uncovered significant shortcomings in the ability of EU banks to adequately cover their exposure to climate-related risk.
In its first-ever large-scale assessment of how European banks are adjusting their practices to manage climate and environmental risks, the ECB found that not one of 112 banks surveyed have come close to meeting all supervisory expectations.
Half of the assessed banks expect climate and environmental risks to have a material impact on their risk profile in the next three to five years, with credit, operational and business model risk most affected. Notably, all the banks which judged that they are not exposed to climate-related risks had significant shortcomings in their assessment of the risks.
In general, banks have made efforts to meet ECB expectations regarding management bodies, risk appetite and operational risk management. However, they lag behind in areas such as internal reporting, market and liquidity risk management, and stress testing. For example, half of banks haven’t planned concrete action to integrate climate and environmental risks into their business strategies, and less than one-fifth have developed key risk indicators to monitor.
Almost all banks have developed plans to improve their practices. However, the quality of these plans varies considerably, says the ECB and progress is too slow.
"Only one-third of banks have plans in place that are at least broadly adequate, and half won’t have completed implementation of their plans by the end of 2022," states the central bank.
The ECB sent individual feedback letters to the banks, calling on them to address their shortcomings, which will will eventually influence their Pillar 2 capital requirements.
As a next step, the ECB intends to conduct a full review of how prepared banks are to manage climate and environmental risks, with deep dives into their incorporation into strategy, governance, and risk management. The review will take place in the first half of 2022, in tandem with the ECB’s supervisory stress test on climate-related risks. Banks will receive a request for information towards the end of 2021.