EU banks unprepared for new climate disclosure rules, finds Spanish central bank

The EU banking regulator has warned banks that climate risks could influence 2022 capital requirements.

EU banks are leaving out details regarding the specific ESG risks they face when reporting their overall risk exposure, the Spanish national central bank (BDE) has said.

Such disclosures are made annually under the EU’s banking supervisory framework and determine the minimum statutory capital buffers that banks will need to keep to offset potential risks and losses. Under the rules, banks are required to disclose information relating to their risks, capital adequacy, and policies for managing those risks.

But a BDE study of reports filed between 2019 and 2020 found that that EU banks only “tend to give generic references to ESG concepts”. According to the supervisor, the most commonly reported risks related to climate change and the environment – at just under 40% of banks in 2020.

However, less than 20% of reporting banks provided details on the underlying transition and physical risks of climate change, while only around 10% reported social and governance risks. BDE noted that it had removed the majority of governance risk reporting from the figure, as banks had had largely reported on their own governance, when they should have focused on the governance risks of clients and other balance sheet assets.

BDE also found that less than 20% of banks referenced the EU green taxonomy and ESG ratings which apply to their portfolio activities.

The supervisor examined the disclosures of 106 large EU banks over two consecutive years as part of the study.

EU banks have not been explicitly required to report ESG risks in the past but they will soon be required to disclose a broad range of metrics under incoming rules announced last year. From June 2022 onwards, banks will be required to disclose the extent of their alignment with the green taxonomy, financed carbon emissions, exposure to “fossil fuel companies excluded from sustainable climate benchmarks” and progress towards net zero goals, among others.

It comes as the EU prudential regulator, the European Central Bank (ECB), warned banks that it would consider climate and environmental risks when determining bank capital requirements from this year onwards.

“2022 will be the year that C&E risks become integrated in the day-to-day activities of our joint supervisory teams, who are in constant contact with banks. These risks will come to form an integral part of our ongoing dialogue with supervised entities and the supervisory review and evaluation process, the SREP,” said ECB supervisory board vice-chair Frank Elderson in a speech last month.

“This will ultimately influence banks’ minimum capital requirements,” he concluded.

While the EU’s existing legislative framework for capital requirements – as set out by the Capital Requirements Directive and Regulation – does not have specific provisions for climate risks, its focus on materiality means that climate and environment issues should be considered “taking into account the specificities of the respective business model, operating environment and risk profile”, according to ECB guidance released in 2020.

Within the medium term, the EU hope to establish a bloc wide position on the use of differentiated regulatory treatments for assets based on climate-risk – for example, by reducing the capital requirements for green assets or increasing requirements for polluting assets. Although the approach has been around for some time, it has proven to be controversial among regulators and has not been put into practice.

The European Banking Agency is due to deliver a research brief on the topic to the EU Commission in 2023.