22 June 2022

SSM's Elderson: Good, bad and hopeful news: the latest on the supervision of climate risks

I understand that today’s audience includes managers and experts from banks and banking associations, supervisors, academics and students. So this is an ideal platform for exchanging views on the financial sector’s role in addressing the risks of the ongoing climate and environmental crises. Conferences like these are a chance to inform each other of what we are doing and to share the knowledge and expertise we are accumulating to gear ourselves to a world that is already undergoing a climate crisis. Physical and transition risks from climate change and environmental degradation are already materialising all around us.

Today I will update you on the recent progress on both the international agenda and the ECB’s own supervisory agenda on climate-related and environmental risks, or C&E risks for short. I will share some preliminary findings from our review of how banks incorporate C&E risks into their risk management practices.

There will be good, bad and hopeful news.

The good news is that, one year after my first speech on the state of C&E risk management by euro area banks as Vice-Chair of the ECB’s Supervisory Board, banks are starting to progress in their management of these risks. The bad news is that this progress is not across the board, and laggards remain in all areas. But there is hopeful news too. The silver lining is that the state-of-the-art governance and risk management practices now being adopted by some banks confirm that what the ECB is asking is possible. We just need all banks to do it.

The new Basel Committee on Banking Supervision principles for the effective management and supervision of climate-related financial risks

All around the world, there is a growing consensus on the urgency of dealing with the climate and environmental crises. For banks, the prominence of C&E risks is significant, too. During various supervisory exercises recently conducted by the ECB, most banks recognised that they have significant exposures to these risks, which they expected to materialise in the short to medium term. And we see that banks are consequently allocating more and more financial and human resources to managing these risks.

And this is what supervisors around the world expect from banks. Just last week, the Basel Committee on Banking Supervision, the main global standard-setter for the prudential regulation of banks, published its “Principles for the effective management and supervision of climate-related financial risks”.

These principles have been prepared in a Basel Committee task force that I co-chair. They are a major milestone, as it means that supervisors from all around the world now unanimously confirm not only that climate risks may be material, but also that both banks and supervisors urgently need to contend with them. The Basel Committee backed this up by announcing it expects implementation of these principles as soon as possible and that it will monitor progress in these fields across its member jurisdictions.

Importantly, the Basel Committee’s principles promote many of the practices that the ECB had signalled as crucial for the proper management of C&E risks. For instance, they emphasise the importance of assessing the materiality of climate risks and considering their potential impact on banks’ business models. They also highlight the need to fully incorporate material risks into banks’ own internal capital and liquidity adequacy assessment processes.

Moreover, the principles expect a bank’s board and senior management to ensure that the bank’s internal strategies and risk appetite statements are consistent with any publicly communicated climate-related strategies and commitments. This expectation comes at a timely moment as more and more banks publicly commit to aligning their financing activities with the objectives of the Paris Agreement. Failing to meet their commitments may expose these banks to a number of risks, including reputational risks as well as any potential prudential risks of misalignment with these objectives. This is particularly true for jurisdictions, such as the European Union, which have binding climate targets.

Addressed to both banks and supervisors, these principles seek to improve, on the one hand, banks’ risk management and, on the other, the supervisory practices linked to climate-related financial risks. Furthermore, the revisions to the Capital Requirements Directive currently under discussion by the EU co-legislators further reaffirm the ECB’s mandate in this area by broadening the supervisory toolkit to address environmental, social and governance risks, and by explicitly requiring banks to have concrete plans to address C&E risks arising from misalignment with EU climate targets.

The ECB’s supervisory agenda on climate

Indeed, since 2020 the ECB has been starting to implement many of the principles that the Basel Committee has now established on a global scale.

It has now been two years since we started taking concrete steps to include C&E risks in our ongoing supervision. In 2020 we published a guide on C&E risks, which outlined our expectations for the management and disclosure of these risks. In 2021 we published a report on banks’ self-assessments of where they stood relative to those expectations and shared some of the good practices we had observed in the banking industry.

Early in 2021 we also asked all banks under our supervision to devise concrete action plans for ensuring full alignment with our expectations. Banks provided us with such plans, and where we found them deficient, we asked them to be sharpened, which was subsequently done. In 2022 we continue to check progress under these action plans by assessing whether banks have advanced the plans submitted in 2021 and the extent to which they use them as an effective steering instrument to advance their C&E risk practices. Moreover, in 2021, for the first time, C&E risks were qualitatively integrated in the Supervisory Review and Evaluation Process (SREP). This year, our joint supervisory teams will complement the SREP assessments with their observations from a climate risk stress test and a thematic review on how banks incorporate these risks into their day-to-day business. This will also be qualitatively integrated in the SREP scores, which may have an indirect impact on minimum capital requirements...

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