Banks struggle with climate and environmental risks

It has been clear that climate and environmental risks feature prominently in the list of priorities of the European Central Bank (ECB) since the publication of its Guide on Climate-related and Environmental Risks in November 2020. The ECB wants banks to take action for the purposes of managing and transparently disclosing climate and environmental risks.

After receiving previous self-assessments and action plans from the most significant institutions, the regulatory authority concluded that initial steps had been taken but that there was still a great deal of room for improvement. At the beginning of this year the regulatory authority again asked the banks to complete a questionnaire concerning their progress in relation to climate and environmental risks (Thematic Review 2022).

Actual implementation suffers delay

In anticipation of the findings of this questionnaire we have already examined the current status of implementation within several significant banks. This has revealed that the areas of focus are still identical to the conclusions which the ECB had previously drawn. Last year the ECB noted that virtually all of the banks which had completed the initial questionnaires had developed a plan to strengthen their risk management capabilities. The majority had made significant progress with the integration of climate risks in their credit risk management processes. In addition, the ECB observed shortcomings in relation to internal reporting, the management of market and liquidity risks, and stress testing.

In relation to our benchmark we also noted that many banks had delayed the actual implementation of climate and environmental risks, even until 2023. Where market risks are concerned, 50% of the banks surveyed had not even commenced implementation. They have indicated that they will start to do so later this year.

Three reasons for the delay

In our opinion there are three general reasons why implementation has been delayed within the banks, namely:

• complexity – because multiple departments are involved in the process and depend on each other, it is difficult to agree on all of the requirements and to assign clearly-defined responsibilities;

• impact – the impact of climate and environmental risks on traditional ones is not always clear. Climate and environmental risks frequently span a lengthier period of time compared with market and liquidity risks;

• other duties – banks are busy focusing on other requirements, such as climate risk stress tests and the EU taxonomy, and consequently have little time available for implementation at present as a result.

Acceleration of the implementation of climate and environmental risks

In order to accelerate the implementation of climate and environmental risks, and to satisfy the ECB’s requirements, it is first of all important that banks clearly identify the owner of the process internally. The appropriate tone at the top is crucial in this respect. The management team frequently views implementation as a mandatory exercise for the purposes of compliance with regulations. By indicating that it is precisely this which can strengthen banks’ risk management processes and, as such, is of great value, managers are able to stress the urgency in the relevant departments. 

In addition, we recommend an upskilling programme throughout the organisation for the purposes of managing climate and environmental risks. Because multiple departments have to work together on implementation, it remains important for all staff to have a basic knowledge of such risks. Specialist training modules can help the relevant departments in this respect.

Danger of financial consequences

The implementation of climate and environmental risks is definitely not a simple task. However, if banks do not take action now, financial consequences will be inevitable, for example, in the form of losses in relation to counterparties as a result of climate or environmental risks, or an indirect capital charge through the ‘supervisory review and evaluation process’ (SREP). 

In our subsequent blog posts we will focus in greater detail on ways to improve implementation. Amongst other things, we will explain the incorporation of climate and environmental risks in liquidity risk management and the lending and monitoring processes.