ECB raises bank capital requirements over climate risks

A “small number” of EU banks have had their capital requirements raised due to weaknesses in their climate and environmental (C&E) risk management processes, said the European Central Bank (ECB) yesterday.

The supervisor has not released details of the institutions affected but said they were among a group of 30 banks which were told to develop implementation plans to address similar shortcomings by a set date. Examples of weaknesses given by the ECB include not conducting materiality assessments and a lack of oversight for C&E risks.

The ECB had warned banks earlier in March that it would consider C&E risks when determining bank capital requirements from 2022 onwards.

Banks are required to set aside capital reserves as insulation from potential losses, part of which is determined by supervisory review. The EU’s current capital requirements framework does not have specific provisions for climate risks but its focus on materiality means C&E issues should be considered, according to ECB guidance released in 2020.

It comes as the ECB released the final results of a thematic review on C&E risks, months after issuing preliminary findings. The review was conducted in tandem with the first EU supervisory stress test on climate-related risks

Out of the 186 banks reviewed, the ECB identified “blind spots” in the identification of C&E risks for 96 percent of institutions – 60 percent of which were considered major gaps. A total of 21 institutions did not report any material C&E risks but “remarkably” not a single one had attempted to comprehensively identify those risks, the ECB said.

The ECB found that more than half of the institutions surveyed have devised some C&E practices but failed to implement them effectively. C&E key performance indicators (KPIs) were seldom cascaded down to business lines and portfolios, and frameworks for corrective action are “frequently absent”, it said.

More broadly, “a wait-and-see approach in strategy-setting is still prevalent”, warned the ECB, with institutions exposed to potential reputational, litigation and liability risks if they do not meet stated climate commitments.

All the large banks involved in the review, 107 of them, received feedback “containing about 25 shortcomings” which will need to be remediated by 2024. This is consistent with an ECB deadline for banks to comply with its expectations on managing climate-related risks issued in 2020.

Writing in a blogpost released alongside the review, ECB supervisory board vice-chair Frank Elderson, warned of banks going against their own policies by continuing to finance “notorious polluters”.

“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. In other words, too many banks are still hoping for the best while not preparing for the worst.

“These banks risk serious repercussions on their balance sheets, particularly where they publicly make ‘green’ claims.”

The EU is currently assessing the merits of using dedicated prudential treatments to determine capital requirements based on climate exposure. This means that supervisors will be able to reduce the amount of capital banks are required to set aside for green assets or conversely increase the requirements for polluting assets – known as introducing a green supporting factor or a brown penalising factor, respectively.

The study is being undertaken by the European Banking Authority and is due to be finalised next year. However, unfavourable early findings have dampened the prospects for such a measure.