The European Central Bank has asked banks to “urgently” improve plans to protect their businesses from climate change risk after a review found widespread shortcomings in borrowers’ approach to environmental challenges.
The ECB, which has directly overseen the largest banks across the eurozone for seven years, has completed its first assessment of banks’ readiness deal with increased climate and environmental risks. It found that no bank under its supervision closely met the ECB’s expectations. The central bank said lenders could “eventually” face higher capital demands, as it integrated climate risk assessments with its regular work to determine individual banks’ capital levels.
The biggest risks for banks come from exposure to energy companies that are not turning to more sustainable activities and energy-intensive sectors such as aviation, according to the assessment. Other risks include loans to buildings that are less energy efficient and therefore may have a lower resale value.
The ECB’s study focused on 112 banks with combined assets of € 24tn. Half of those borrowers said climate change would have a “significant” impact on their businesses over the next three to five years. None of the banks that reported climate risks as “insignificant” did adequate analysis, wrote Frank Elderson, ECB’s Executive Councilor and Vice – Chairman of the ECB’s Supervisory Board, in a blog post.
Other shortcomings highlighted by the ECB include a lack of stress testing to see what would happen to banks’ businesses in various climate change scenarios, and poor planning for how to make their business models more resilient in the face of climate change. The banks with the biggest shortcomings were encouraged to rectify this as part of the ECB’s regular supervision.
“Banks urgently need to set ambitious and concrete targets and timelines – including measurable interim milestones – to mitigate their exposure to current and future climate and environmental risks,” Elderson wrote.
Sasja Beslik, head of sustainability at Denmark’s largest pension fund PFA and a prominent environmental, social and management investor, said he did not expect banks to make “major improvements” in their climate risk management strategies “before seeing financial losses. [from lending to unsustainable industries]”.
“Banks reflect the real economy; the real economy is not sustainable, so the way banks operate is not sustainable, ”he added.
Where climate change meets business, markets and politics. Explore the FT’s coverage here.
Are you curious about the FT’s commitments for environmental sustainability? Find out more about our science-based targets here
The ECB did find some bright spots. Elderson said two-thirds of banks have made “significant progress” in offsetting climate risk in their lending decisions, by taking extra care about lenders’ climate risks or phasing out loans to some of the most exposed industries.
The ECB will publish a report on banks ‘climate risk disclosures in the first quarter of 2022 and plan a broader overview of banks’ strategy, management and risk management around climate change risk in the first half of next year. The review will only reveal results for the financial system, not for individual lenders.
In the UK, banks last month submitted data for the Bank of England’s first climate “stress tests”, which the BoE described as “exploratory in nature” without any impact on capital requirements. Results, which will be presented as total findings for the UK banking system, are scheduled to be published by May.