23 September 2022

SSM's Tuominen: The way towards banks’ good climate change risk management

One of the ECB’s main supervisory priorities has been to ensure that banks emerge from the pandemic healthy. The start of 2022 looked promising in this respect. Thanks to the extraordinary support measures, the banking sector did not seem to be suffering major asset quality problems, and the profitability outlook was good.

However, following Russia’s aggression against Ukraine, the situation has changed dramatically. The systemic risks originating from a deteriorating economic outlook and high indebtedness have increased. Meanwhile, geopolitical risks have led to high energy prices and supply shocks disrupting the economy. We are also seeing a sizeable increase in the cost of risk, together with lower lending volumes owing to low demand. All of this will have an impact on banks. It is however questionable whether governments are as willing or as able to support businesses as they were during the pandemic.

But what does this mean for climate-related and environmental risks? Will the impact of the war lead to a temporary postponement of the transition to a greener economy, or will it instead accelerate the transition thanks to technological innovations and reorientation of investments? Banks need to be prepared for both scenarios. Strong expertise and knowledge of climate issues, also at board level, will be essential as banks confront the enormous challenges posed by climate change.

Preparedness and vulnerabilities of banks

Climate-related and environmental risks for banks include the transition towards a more sustainable economy and the need to adapt to increasing physical threats. Tackling climate-related and environmental risks is one of the ECB’s key supervisory priorities for 2022-24^[1]. We have therefore set a strategic objective for banks to proactively incorporate climate-related and environmental risks into their business strategies and their governance and risk management frameworks. This will enable banks to mitigate and disclose such risks and comply with the corresponding regulatory requirements. But where do banks stand at present?

The ECB has carried out several supervisory exercises that have provided information on banks’ preparedness.

In 2020 the ECB published its Guide on climate-related and environmental risks, outlining its supervisory expectations regarding banks’ risk management and disclosure in this area.^[2] Subsequently, banks were asked to perform a self-assessment. In doing so, most banks recognised that they have significant exposures to climate-related and environmental risks. However, 90% of the banks said that they were only partially or not at all aligned with the ECB’s supervisory expectations and, in particular, saw a need to improve the way they manage and disclose these risks.^[3]

This year, climate-related and environmental risks have been further integrated into the day-to-day supervisory tasks, forming part of the ongoing dialogue with banks and the annual Supervisory Review and Evaluation Process – the SREP.^[4] As part of the SREP, climate-related and environmental risks can ultimately influence banks’ minimum capital requirements.

SRB

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