ON 2 NOVEMBER 2022, THE EUROPEAN CENTRAL BANK ("ECB") PUBLISHED ITS THEMATIC REVIEW AND GOOD PRACTICES FOR CLIMATE-RELATED AND ENVIRONMENTAL RISKS.
The two documents relating to how banks are dealing with climate and environmental risks:
- a document titled "Walking the talk - Banks gearing up to manage risks from climate change and environmental degradation", which includes the results of the ECB's 2022 thematic review on climate-related and environmental risks ("2022 Thematic Review"); and
- a document titled "Good practices for climate-related and environmental risk management", which includes observations from the 2022 Thematic Review ("2022 Good Practices").
Both documents should be read in conjunction with the ECB Guide on climate-related and environmental risks published in November 2020 ("ECB Guide").
Scope and aim
The 2022 Thematic Review covered 107 significant banks under the direct supervision of the ECB and 79 less significant banks supervised by their national authorities.
It aims to foster the alignment of the banking sector with the supervisory expectations set out in the ECB Guide, by verifying whether banks adequately identify and manage climate risks and environmental risks such as biodiversity loss, and analysing banks' risk strategies and their governance and risk management processes.
The 2022 Thematic Review was conducted in tandem with the ECB's first supervisory stress test on climate-related risks, within which banks' stress testing frameworks were assessed.
Key findings
The key findings of the 2022 Thematic Review include the following:
- there is broad acknowledgement within the banking sector of the materiality of physical and transition risks within the current business planning horizon;
- most institutions have now devised an institutional architecture to address climate-related risks, having clearly built up their capabilities compared with 2021;
- some institutions have started to use transition planning tools, along with targeted client engagement to enhance the resilience of their business model over longer time horizons, but a wait-and-see approach is still prevalent;
- virtually all the institutions need to make far-reaching and enduring efforts to develop consequential, granular and forward-looking approaches to manage climate and environmental risks;
- institutions need to make further efforts to attain an acceptable degree of coverage of key portfolios, geographies and risk drivers;
- notwithstanding the progress made by many institutions on their implementation plans, the ECB expresses significant supervisory concern regarding the execution capabilities of around half of the institutions.
The ECB concludes that, despite improvements, banks are still far from adequately identifying and managing climate and environmental risks.
However, the ECB also notes that the good practices observed in numerous institutions demonstrate how the sector can harness innovation to address the prevailing challenges and that good practices are being deployed in relation to broader environmental risks, with institutions leveraging existing climate-related risk approaches.
The 2022 Good Practices is seen as a key supervisory publication in this respect, as it shares observations and good practices and illustrates the different ways that significant institutions can align their practices with the supervisory expectations set out in the ECB Guide.
The 2022 Good Practices should be read in conjunction with the ECB's report on good practices observed in the climate-related stress test, which is to be published later this year. While the report on climate-related stress testing will focus primarily on stress testing and risk modelling, the 2022 Good Practices covers observed practices related to strategy-setting, governance and risk appetite, as well as risk management.
Key deadlines
As a result of the findings of the 2022 Thematic Review, the ECB is setting institution-specific staggered deadlines for banks to progressively meet the supervisory expectations laid down in the ECB Guide:
- By March 2023 – banks must adequately categorise climate and environmental risks and conduct a full assessment of their impact on the banks' activities;
- At the latest by end of 2023 – banks must include climate and environmental risks in their governance, strategy and risk management;
- By end of 2024 – banks are expected to meet all remaining supervisory expectations on climate and environmental risks outlined in the ECB Guide
The ECB makes clear that these deadlines will be closely monitored and, if necessary, enforcement action will be taken.
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Read the 2022 Thematic Review here_
Read the 2022 Good Practices here_
Access our timeline on key ESG milestones in the banking and insurance sectors here_
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