Financial institutions are demonstrating increased proficiency in handling risks related to climate change and the environment, according to the European Central Bank.
In a recent statement, Frank Elderson, Executive Board Member of the European Central Bank (ECB), acknowledged the progress made by banks across Europe in addressing climate and nature-related risks. However, he also emphasised that there is still room for improvement in several key areas.
The ECB's climate stress test in 2022 revealed that banks need to accelerate the incorporation of climate risk into their risk management frameworks, as they remain heavily exposed to emissions-intensive industries. The test also highlighted that some banks in the EU have not yet included all material risk drivers, relevant portfolios, or transmission channels in their management of climate risk.
According to Elderson, banks must enhance their ability to accurately assess and identify the material risks that climate change and nature degradation pose to their portfolios, a crucial precondition for effective management. Banks also need to more fully embed these risks into their existing prudential frameworks.
There remains a significant lack of comprehensive data and understanding around nature-related risks, which hampers banks' ability to evaluate economic and financial implications fully. Banks should improve in conducting precise self-assessments and participate in climate risk stress tests, as well as enhance transparency about their exposures to physical and transition risks linked to climate change.
Elderson highlighted the importance of addressing these deficiencies through ongoing supervisory efforts, clear interim and final deadlines for compliance, and by leveraging policy and market tools. However, he also noted that bridging the data and knowledge gaps requires coordinated action beyond central banks alone.
The ECB's decision to step up efforts to address climate change as one of its top priorities for bank supervision for 2023-2025 was made in late 2022. Since then, banks in the EU have made significant strides in addressing and managing climate and nature-related risks. For instance, more than 90% of banks now consider themselves to be materially exposed to climate-related and environmental risks, compared with only half of banks reaching this assessment in 2021.
By the end of 2024, the percentage of banks found to not have any climate-related and environmental risk management practices in place dropped from 25% in 2022 to only 5%. Furthermore, more than half (56%) of banks had leading climate-related and environmental risk management practices for at least some exposures in alignment with ECB supervisory expectations, compared with only 3% of banks in 2022.
However, Elderson noted that while progress has been made, more work needs to be done by European banks to expand these risk identification and management practices across all relevant exposure areas and risk categories. Mortgage lending is not always fully considered in banks' management of climate and nature-related risks in the EU.
Many banks in the EU are applying sound climate and environmental risk management practices only to a subset of their relevant exposures, risk categories, and geographical areas. Therefore, it is crucial for banks to ensure that these practices are applied consistently across all areas to effectively manage these risks.
In conclusion, European banks need to improve in risk identification through materiality assessments, integration of climate and nature risks into existing frameworks, closing data gaps, and enhancing supervisory compliance and disclosure to manage these risks properly. The ECB will continue to support banks in this endeavour and encourage them to make further progress in the coming years.
- To effectively manage climate and nature-related risks, European banks must strive to integrate these risks into their existing prudential financial frameworks, as suggested by Frank Elderson, Executive Board Member of the European Central Bank.
- In addition to strengthening their risk management practices, banks should also address the significant lack of comprehensive data and understanding around nature-related risks, a critical step towards fully evaluating economic and financial implications and making well-informed business decisions.
