Banks in the eurozone are making progress in managing climate and natural risks but “need to do more,” stated the vice-chair of the ECB’s Supervisory Board, Frank Elderson, in a blog post published today.
The ECB is currently assessing whether to impose mandatory financial penalties on banks that fail to adequately consider these risks.
Banks now have a better understanding of the climate and environmental risks they face, added Elderson.
About 90% of the largest banks in the eurozone now consider themselves exposed to these risks, compared to only half in 2021.
Elderson notes that banks are including climate and nature-related risks in credit risk but not as much in other risk categories, such as operational or market risk.
The vice-chair of the ECB’s Supervisory Board views stress tests as “a fundamental tool to better quantify where climate and nature-related risks are” and to calculate the capital needed to cover these risks.
All banks have included climate risk in their stress testing frameworks, compared to 41% that included climate risk in their stress testing frameworks in 2022.
However, three-quarters of the banks do not cover all significant climate and nature-related risk factors when calculating their capital requirements, indicating that these risks are underestimated.
Only a third of banks incorporate these risks into their capital plans.
Banks greatly underestimate the risk of floods, heatwaves, or fires because they do not include them in the calculation of the capital needed to absorb losses.
The climate crisis is developing faster than anticipated, impacting at lower temperatures than previously estimated.
Elderson believes European banks are well-prepared to meet the transition planning requirements coming into effect in 2026.
In late this year and 2026, the ECB will initiate an informal dialogue with credit institutions to discuss progress, challenges, and areas for improvement.
In 2027, the ECB will conduct a more formal assessment, added Elderson.
