HomeBlogFinanceECB warns banks of capital hit if they fail to tackle climate risk

ECB warns banks of capital hit if they fail to tackle climate risk

The European Central Bank has warned banks that failing to tackle their financial risks from climate change in the next two years will result in higher capital requirements and fines, ramping up the pressure after finding widespread areas of concern.

All the large eurozone banks have been sent letters by the ECB identifying 25 areas, on average, where it believes they are falling short in addressing climate risks and setting the 2024 deadline to address the issues.

A “small number” of banks have already had their capital requirements raised by the ECB this year due to concern about their failure to address climate risks sufficiently, the central bank said on Wednesday. This was under what is known as “pillar two” capital requirements that are binding and are calibrated for the risk of each bank.

Progress in meeting its deadline “will be closely monitored and, if necessary, enforcement action will be taken,” the ECB added.

It said 30 banks were set “binding qualitative requirements” — such as to improve governance or assessment of climate risks — in the latest annual review.

The moves mark a sharp intensification of pressure from the central bank on eurozone lenders to step up their action to detect, manage and disclose climate risks in their balance sheets. “The glass is filling up slowly but it is not yet even half full,” Frank Elderson, vice-chair of the ECB’s supervisory board, wrote in a blog.

The ECB published the results of its latest “thematic review” into how the 186 lenders are tackling climate and environmental risks. It found “blind spots” at 96 per cent of the banks in “key sectors, regions and risk drivers” of which 60 per cent had “major gaps”. 

“Most banks have thus not yet answered the question of what they will do with clients who may no longer have sustainable revenue sources because of the green transition,” said Elderson. “In other words, too many banks are still hoping for the best while not preparing for the worst.”

The ECB expects banks to “adequately categorise” climate risks and assess how they impact their activities by March 2023. It wants them to include climate risks in their “governance, strategy and risk management” by the end of next year, and to incorporate climate risks into their internal capital adequacy assessment process and stress tests by the end of 2024.

The central bank did find some signs that banks are taking the issue more seriously. More than 80 per cent of banks accepted that climate risks would have a “material impact on their risk profile and strategy” — up from 50 per cent last year — while 85 per cent had “at least basic practices” in the key areas required to tackle the issue.

It published a list of “good practices” of which it said a quarter of banks were implementing at least one. These included linking executives’ pay to managing climate risks, allocating capital to account for specific climate risks or ditching clients that rely on coal for more than a quarter of their energy.

However, Elderson said: “Most banks’ strategy documents are full of references to climate change, but actual shifts in revenue sources remain rare.”

“We also find that certain banks have ignored clear warnings from their own specialists,” he added. “These banks risk serious repercussions on their balance sheets, particularly where they publicly make ‘green’ claims.”

The ECB carried out its debut climate stress test this year to model the impact of global warming and extreme weather on banks’ balance sheets. The 41 biggest eurozone lenders estimated they could suffer €70bn of losses from these risks over three years, but the central bank warned this “significantly underestimates the actual climate-related risk”.

*This article was amended from the original to clarify the nature of “pillar two” requirements.

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