The ECB guide on climate-related and environmental risks aims to assist financial institutions in integrating these risks into their management. It emphasizes the importance of a strategic and comprehensive approach to anticipate the impacts of environmental risks on business models and governance. This document is part of European efforts to achieve a sustainable and carbon-neutral economy by 2050.
This document is a guide published in November 2020 by the European Central Bank (ECB) - Banking Supervision (Single Supervisory Mechanism, SSM). It addresses risks related to climate and the environment, particularly their prudent management and disclosure in the euro area banking sector. The guide is mainly intended for significant institutions supervised directly by the ECB, covering physical and transition risks linked to climate change and environmental degradation, as well as their integration into existing prudential frameworks (CRD/CRR). The scope includes microprudential risks affecting banks, over short, medium, and long-term horizons, in connection with international commitments (Paris Agreement 2015, European Green Deal) and European and international initiatives on sustainable finance.
- Subject: The guide addresses the ECB's expectations regarding the management and disclosure of climate and environmental risks by euro area banks, within the SSM framework.
- Importance: These risks are identified as key risk factors for the European banking system, with potential impacts on financial stability, solvency, and liquidity of institutions.
- Main findings: Banks recognize the materiality of physical and transition risks but still mostly approach these issues from a social responsibility perspective, lacking robust methodologies and full integration into risk management and strategic processes. Practices are heterogeneous, with few institutions fully integrating these risks into their stress tests, risk appetite, or capital assessments.
- Conclusions: The ECB expects banks to adopt a strategic, forward-looking, and comprehensive approach, integrating these risks into their business model, governance, risk management, and disclosure processes. It emphasizes the need to adapt tools, key performance indicators (KPIs), and governance, as well as the importance of increased transparency.
- Recommendations: Banks must understand the impact of climate risks on their business environment, integrate these risks into their strategy and risk appetite, clearly assign responsibilities within their organization according to the three lines of defense model, develop appropriate indicators and stress scenarios, and improve the quality and frequency of their internal and external reporting. The ECB will initiate a supervisory dialogue from 2021 to assess gaps and support progressive compliance (pp. 1-31).
- The guide was developed in response to the growing importance of risks related to climate change and environmental degradation for the financial sector, within the framework of international commitments (Paris Agreement, 2030 Agenda) and European initiatives (Green Deal).
- These risks represent structural factors affecting the real economy and the financial system, notably through physical risks (extreme events, gradual degradation) and transition risks (adaptation to a low-carbon economy).
- The ECB aims to clarify its expectations regarding the prudent management and disclosure of these risks, relying on the existing regulatory framework (CRD/CRR) and international recommendations (EBA, NGFS, TCFD).
- The objective is to improve banks' resilience to these risks, encourage better integration into strategic and risk management processes, and increase transparency towards stakeholders.
- The guide serves as a basis for supervisory dialogue, without being legally binding, and takes into account the still evolving maturity of available methodologies and data (pp. 4-10).
Definitions and characteristics of risks (pp. 10-14):
- Climate and environmental risks are divided into physical risks (extreme events, gradual degradation) and transition risks (financial losses related to adaptation to a sustainable economy).
- These risks impact several existing financial risk categories: credit, operational, market, liquidity, as well as non-Pillar 1 risks such as strategic or reputational risk.
- Their magnitude depends on the pace and nature of the transition, with potentially significant impacts on asset values and profitability.
- These risks have a long-term horizon, often exceeding the average duration of loans, requiring a forward-looking approach.
- Banks must consider sectoral and geographical specificities, as well as interdependencies between climate and environmental risks.
Observations on current practices (pp. 14-16):
- Banks recognize the materiality of risks but mostly address them from a CSR perspective.
- Few institutions have integrated these risks into their risk management, stress tests, or capital assessment.
- Public disclosures are limited and heterogeneous, often not compliant with TCFD recommendations.
Expectations regarding business model and strategy (pp. 16-21):
- In-depth understanding of the impacts of climate risks on the business environment over short, medium, and long term.
- Explicit integration of these risks into corporate strategy, supported by scenario analyses and quantifiable KPIs.
- Documentation and monitoring of impacts in governance bodies.
Governance and risk appetite (pp. 21-31):
- Active involvement of the board and committees, with clear allocation of responsibilities.
- Requirement for specific climate risk skills within governance bodies.
- Explicit inclusion of climate risks in the risk appetite framework, with defined limits and adapted indicators.
- Alignment of remuneration policies with climate objectives.
- Establishment of a clear organization according to the three lines of defense model, with adequate resources and training.
- Regular, aggregated, and adapted internal reporting enabling informed decision-making.
Risk management (pp. 31-33):
- Integration of climate risks as factors within existing risk categories.
- Identification, quantification, and documentation of risks, including concentrations and interactions.
- Use of adapted scenarios and stress tests to assess resilience.
- Adaptation of information systems to collect and aggregate necessary data.
Disclosure (not covered in the provided pages):
- The guide sets expectations on transparency and quality of published information, aligned with European and international standards.
- Established facts:
- Climate and environmental risks are major risk factors for the European banking sector.
- Banks have heterogeneous practices, often limited to a CSR approach.
- Few institutions have integrated these risks into their risk management and capital assessment processes.
- Disclosures are underdeveloped and poorly standardized.
- Assumptions:
- The impact of risks will depend on the pace and nature of the transition to a sustainable economy.
- Methodologies and data to quantify these risks are under development.
- Interpretations:
- Integrating climate risks into risk management and strategy is essential for banks' resilience.
- Governance must be strengthened with specific skills.
- Supervisory dialogue is a lever to support banks in this integration.
- Uncertainties:
- Regulatory evolution and international standards are under development.
- Data and methodologies remain immature, limiting precise risk quantification.
- The ECB recommends that banks adopt a strategic, forward-looking, and comprehensive approach to managing climate and environmental risks.
- Banks must integrate these risks into their business model, strategy, governance, risk appetite, risk management, and reporting processes.
- Banks are expected to develop key performance indicators and adapted stress scenarios covering short, medium, and long term.
- Governance must include clear responsibilities, specific skills, and regular reporting to management and the board.
- Banks must adapt their information systems to collect and aggregate necessary data.
- The ECB will initiate a supervisory dialogue from 2021 to identify gaps and monitor banks' progress towards compliance with expectations.
- The guide is not legally binding but serves as a basis for dialogue and progressive evolution of practices.
- Banks are encouraged to rely on international and European publications and standards (EBA, NGFS, TCFD, etc.) to improve their practices.
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