European banks fail climate change risk test

European banks have failed a climate change risk test in first survey of the sector by the regulator European Central Bank.

Risk management at none of the banks was “close to aligning their practices with the supervisory expectations,” ECB said. In fact, 90 per cent of the 112 institutions said they were not ready to properly align climate-related and environmental risk (C&E) with requirements in their self assessments.

“Virtually all institutions that performed a thorough materiality assessment expect C&E risks to have a material impact on their risk profile in the coming three to five years,” the report found. Those who did not think C&E would have a big impact on them had not done their assessments properly, ECB said.

Risk reporting

Most banks have failed to develop effect C&E risk reporting mechanisms. For example, most do no know what data they need to identify and report on C&E risk. In addition, only one if five banks include dedicated risk indicators for such threats in their risk appetites.

The banks also had gaping blind spots in their risk drivers. For example, physical risk management practices lagged those for transition risk. And very few banks had a clue about biodiversity and pollution risk related to their activities.

So, while management boards are taking formal responsibilies for these risks, risk identification and reporting is not up to scratch according to the climate change risk test.

Improvement plans

The ECB asked banks to develop implementation plans to improve their practices on E&C risk. The quality of those plans varied greatly and had slow implementation timelines.

“More than half of the institutions will not have completed their plans by the end of 2022 with a subset of those, amounting to roughly one-fifth, not having any short-term deliverables in place,” the report said. “These institutions may not be able to soundly, effectively and comprehensively manage C&E risks that they are exposed to.”

IRM’s Climate change risk management guidance is available here.

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