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Just two in five European banks have climate risk testing
frameworks in place, but fewer than half are currently using the
results of those tests to drive their business strategies, the
European Central Bank (ECB) said 8 July.
Announcing the results of the central bank's
"first-ever climate stress tests," the ECB said just 19% of the
banks that already have climate stress test frameworks are using it
to inform their loan granting process.
The ECB, which crafts, manages, and implements the EU's economic
and monetary policy, said the test results show 41.35% of the 104
participating banks have incorporated climate risk testing
frameworks, while 58.65% lack them.
Eurozone "banks are far from where we need to be," ECB
Supervisory Board Vice-Chair Frank Elderson said in a
video message on Twitter. But, he added, "we expect banks to
take decisive action and develop robust climate stress-testing
frameworks in the short to medium term."
ECB released the results four days after it announced steps to decarbonize its
monetary policy operations.
Failure to disclose climate risks
The outcome of the climate stress tests complements what the ECB
uncovered in March about
climate risk assessment and disclosure in the financial sector. At
least three-quarters of European banks are failing to disclose the
material impact of climate and environmental risks to the global
financial system, even though half of them have acknowledged
exposure to such risks, it said.
Climate change and the transition to net-zero carbon emissions
pose risks to households and firms, and, therefore, to the
financial sector. Accordingly, ECB said, exposure to
climate-related and environmental risks is among the ECB's banking
supervision unit's strategic priorities for the 2022-24 period.
The results of the climate stress tests will complement a
"thematic" review that the ECB said it is conducting in parallel to
assess the progress banks are making to improve climate-related and
environmental risk management.
Environmental advocates told Net-Zero Business Daily by
S&P Global Commodity Insights that the ECB climate stress test
results show that Eurozone banks that do not have a framework in
place clearly face substantial exposure for failing to account for
the physical risks they face through droughts, floods, and heat
waves in countries where they are investing.
The results "validate the serious concerns that climate
campaigners and progressive investors have been expressing for
years—that financial institutions urgently need to raise the
bar when it comes to assessing and incorporating climate and energy
transition risks into their lending decisions," wrote Arjun Flora,
energy finance studies director for Europe at the Institute of
Energy Economics and Financial Analysis, in an 8 July email.
Heavy reliance on carbon-intensive
industries
According to the ECB, banks generate 65.2% of their income from
interest on loans to GHG-intensive sectors including real estate,
energy, and agriculture.
"While banks continue to rely on carbon-emitting sectors for
income," Flora said, "they are ultimately gambling with our
collective future and ignoring the clear and tangible long-term
value that would be created through a planned, accelerated
transition to a sustainable economy."
The ECB is one of 114 central banks and financial supervisors
across five continents that now make up the Network for Greening
the Financial System (NGFS) that have voluntarily come together to
share best practices on climate and environmental risk management.
In late December, the NGFS issued a "how to guide" for
central banks on assessing and disclosing climate risk across their
own operations, as well as for the financial systems they
oversee.
Ability to assess, respond to climate
risks
Elderson said the ECB looked at the banks' ability to "analyze,
assess, and respond to climate-related and environment stress."
Banks are exposed in varying degrees to the material effects of
acute physical risks in Europe through droughts, extreme heat
events, and floods. The risks banks face are closely linked to the
geographical location of their lending activities that could in
some cases lead to what the ECB said are "non-negligible
losses."
As part of its climate stress-testing exercise, ECB asked banks
it oversees to provide information on their climate-stress testing
capabilities, reliance on carbon-emitting industries, and
performance under different climate scenarios. The last "bottom-up
stress test," directed at 41 banks that the ECB directly
supervises, revealed that climate-related losses in the next three
years could amount to €70 billion ($71.14 billion).
ECB acknowledged that the estimate understates the actual
losses, owing to lack of data and weaknesses in modeling. Moreover,
it said the underestimation failed to account for economic
downturns and covered only a third of the banks' total balance
sheet exposure.
Climate action plan
ECB said the test, which is part of its broader climate agenda, was not "a
capital adequacy exercise but rather a learning one for banks and
supervisors alike."
In these principles, the Basel Committee encouraged central
banks to develop a process to understand and assess the potential
impacts of climate-related risk drivers on their businesses and,
more importantly, the environments in which they operate. It also
said central banks should consider and plan for material
climate-related financial risks beyond their business-as-usual,
two-to-three-year planning horizons and fold them into their
overall business strategies and risk management frameworks.
In April 2021, the Basel Committee said uncertainty about the
nature of climate change and lack of data, especially from banks,
hinders the ability of central banks to estimate and quantify the
risk that climate change poses to the financial system.
Moving away from carbon-intensive
industries
In addition to its supervisory role, the ECB is taking steps to
align its monetary policy operations with the EU goal of achieving
net-neutrality by mid century.
On 4 July, the Governing Council of the ECB said it would
gradually lessen its reliance on high carbon-emitting industries in
corporate bond holdings as early as this October, and start issuing
quarterly reports on the climate-related information of its
corporate bond holders in the first quarter of 2023.
By the end of 2024, the ECB also will limit the shares of high
carbon assets that companies can use as collateral. Initially, this
limit will be applied to non-financial corporations, but will
expand to other asset classes, such as market debt instruments
issued by financial institutions and bank loans and credit claims.
In the interim, ECB officials said it would engage in test runs
across asset classes to prepare them for the upcoming limits.
Moreover, the ECB said it will give greater weight to companies
that are complying with the EU's Corporate Sustainability
Directive, once it has been implemented. ECB expects that to happen
by 2026.
The ECB said it is consciously "tilting" towards environmental,
social, and corporate governance (ESG) via its reinvestments of the
corporate sector purchase programme (CSPP), which amounts to €30
billion ($30.52 billion) a year, or just slightly more than 10% of
the bank's corporate portfolio.
Given the importance of considering and aligning financial
activities with climate impacts, "the ECB steps are very welcome,"
Jurie Yada, program lead for EU sustainable finance with thinktank
E3G, told Net-Zero Business Daily 8 July.
Yada said these steps give the "right regulatory signals" to the
market and will put pressure on "companies to consider and move
towards lower emission transitions in their activities in order to
qualify for bonds issuance."
Posted 08 July 2022 by Amena Saiyid, Senior Climate and Energy Research Analyst
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.
