Eurozone banks under fire for poor climate risk disclosures

The European Central Bank’s (ECB’s) supervisory assessment of institutions’ climate-related and environmental risk disclosures report, published in March, found that for the second year running, eurozone banks came up short on sufficiently disclosing their climate risks, with no bank fully meeting the ECB’s supervisory expectations on climate risk disclosures.

The report was based on an assessment conducted at the end of 2021, with a sample of the 109 banks under the supervision of the ECB. It found that while some progress had been made from the year before, 75% of banks still do not disclose whether climate and environmental risks have a material impact on their risk profile. Meanwhile, almost 60% of banks do not describe how transition or physical risk could affect their strategy and only 15% of banks disclose Scope 3 finances emissions. Also, around 30% of banks that have committed to aligning their exposures with the Paris Agreement failed to provide any information to support this.

“Banks still have a long way to go,” says Patrick Amis, director general for specialised institutions and less significant institutions at the ECB. “Climate risk disclosures provide essential information for banks´ stakeholders and they are also key for banks to understand climate risks in a forward-looking way.”

Victoria Hickman, a senior associate in the financial regulation practice at Linklaters, says this latest report “is the clearest statement that the ECB has made against the banks’ compliance with their disclosure expectation”.

“In 2020, the ECB undertook a stocktake of bank disclosures in this space, at the same time as launching a guide on climate-related and environmental risks,” says Ms Hickman. “The stocktake identified that, at that time, banks’ disclosures would not comply with the minimum level set in the guide. Now, this 2022 report … evaluates how far they have come towards compliance. The ECB’s answer is ‘not very far’.”

Lack of data 

So why are banks continuing to fail to meet the ECB’s climate risk disclosure expectations? One frequently cited response from banks is the lack of data.

“The financial sector reports that the real problem is that they don’t have the data available yet, and there are associated issues of data reliability and comparability, even where data is available,” says Ms Hickman. “Many banks are getting ready for their first taxonomy regulation reports and are facing the same significant data challenges with that.”

“Disclosure is a hugely important tool for financial institutions to understand their exposures and therefore to be able to address climate risks,” says Nick Villiers, director of the Centre for Sustainable Finance at the University of Cambridge Institute for Sustainability Leadership. “In light of this, banks not meeting supervisory expectations is clearly concerning. However, the majority of banks and other financial institutions’ climate risks stem from their exposures to corporate and other customers; therefore, the financial institutions are reliant on disclosures from these parties.”

In contrast to the EU, the UK requires climate risk disclosure from corporates before that from banks. “Once corporates have started to disclose their own climate risks, financial institutions must quickly make progress in their own disclosures, and I would expect regulators to ensure this is the case,” says Mr Villiers.

“The lack of available data is something we frequently hear from banks,” says Mr Amis. “It’s important that banks start looking also themselves for alternative solutions to fill their data gaps.”

However, Thomas Pfuhler, a managing director and partner with expertise in risk management in financial services at Boston Consulting Group, says the “availability of data is one part of the problem”.

“More broadly, the complexity of this topic is enormous,” says Mr Pfuhler. “It’s a new angle for banks how to look at their business. Just compare how long it has taken to get capital regulation right. In 1988, the Basel regulations were introduced, and regulators and banks are still refining it now. It’s been a 30-year process. Climate risk regulation is only in year two.”

Samy Lakhdari, a financial institutions analyst at Natixis, agrees. “The next big regulatory hurdle for banks is environmental, social and governance (ESG), and this a new thing for banks to adapt their business models to,” he says. “This is why at this stage no banks are aligned with the ECB’s expectations in terms of their climate risk disclosures and transparency. Banks have made some progress compared to the year before, but they need time in order to meet the ECB’s expectations.”

Consistency of data and measurement of climate risks is also important. “To bring that consistency across the financial system, initiatives such as the Glasgow Financial Alliance for Net Zero and its member alliances are working to map what a good transition plan looks like across sectors, providing clarity to both corporate and financial institutions,” says Mr Villiers.

“In addition, whilst we are seeing more Task Force on Climate-related Financial Disclosures (TCFD)-aligned reporting, the principle-led nature of TCFD can lead to different reporting outcomes,” he says. “I would hope that the development of the International Sustainability Standards Board will create globally adopted consistent reporting standards around climate and beyond, that can then be audited to provide greater consistency.”

Enforcement

Following its report in March, the ECB sent individual feedback letters to banks explaining their shortcomings and urging them to act.

The central bank is set to review banks’ climate and environmental disclosures again at the end of 2022. If banks continue to fall short on the ECB’s expectations, it could take enforcement action as a breach of the Capital Requirements Regulation.

“The ECB, like any regulator, has enforcement powers,” says Ms Hickman. “Among these, it can publicly name and shame the banks that are not meeting its expectations, and it can impose financial penalties and liaise with national supervisors to request they take action.”

In a keynote speech at the European Bank Institute Policy Webinar in March, Frank Elderson, a member of the executive board of the ECB and chair of the supervisory board of the ECB, said the central bank had the option to “publicly list those banks which repeatedly fail to disclose their [climate and environmental] risks”.

“When you think how long it’s been since the Paris Agreement, climate risk disclosures are not exactly a novelty,” says Mr Amis. “Banks are lagging behind and we have an array of tools we wouldn’t rule out using to point banks in the right direction. However, we also see banks making good progress and that’s what matters. This is a journey for banks.”

As Mr Amis points out, progress has already been made. More than 70% of the assessed banks now explain how their board oversees climate and environmental risks, compared to just over 50% in 2020, according to the ECB’s report.

Impact on banks’ capital

Despite progress, the overall level of disclosure is still insufficient, especially as regulation of climate and environmental risk disclosures for banks is expected to become even stricter in the coming years. For example, the ECB is understood to be considering climate risk in the context of its Supervisory Review and Evaluation Process (SREP) and Pillar 2 decision-making. 

“If we move from Pillar 3 to Pillar 2 requirements for climate risks, this will impact bank’s capital levels,” says Mr Lakhdari. “This could result in a kind of mandatory ESG buffer for banks to set aside capital in order to face risks stemming from the climate. But this will not happen in the short or medium term; it will likely be a requirement from 2024 onwards.”

“It is only logical that if climate creates risks for banks, then those risks should be taken account of in their capital requirements,” says Mr Villiers. However, rather than banks having a separate ‘ESG buffer’, he would prefer to see ESG climate risks built into the overall risk assessment of banks, reflecting climate as a core risk to banks’ businesses rather than an ESG ‘overlay’ that incongruently sits outside core business exposures and decisions.

“The rationale for a separate buffer would be if the portfolio effect of those exposures was different to the sum of its parts, though integration of climate — and indeed other sustainability risks around nature and social topics — feels like a necessary action to be able to properly address the challenges we collectively face,” Mr Villiers adds.

The results of the ECB’s debut climate stress tests will also feed into the SREP from a qualitative point of view, but no direct capital impact is expected this year, and ultimately “only a handful of banks, in extreme cases, will have their Pillar 2 capital requirements impacted” by the climate stress tests, Mr Amis notes.

The ECB launched its climate stress tests for eurozone banks at the start of the year, with the results set to be published in July. However, the ECB has said it is more of a learning exercise for banks and supervisors to assess how prepared banks are for dealing with financial and economic shocks stemming from climate risks.

 “We are working intensively on measuring the so-called ‘financed emissions’,” a spokesperson from Commerzbank told The Banker. “We expect these emissions to become more tangible in the future, the better the data availability and the more established the methodologies.

“We don’t consider climate risks as a separate, new risk type, but as a cross-cutting risk factor that can materialise in the known risk types — especially in credit risk. We regularly assess the materiality of climate risks as an influencing factor on the basis of scenarios and for all material risk types. We are making significant progress with regard to the bank’s sustainable alignment and we feel well equipped to meet ECB’s expectations with regard to climate risk disclosures.”

Meanwhile, BNP Paribas told The Banker: “Working together effectively calls for greater transparency on the actions taken by the various economic players,” adding that the bank has published an annual report on climate-related risks and opportunities since 2019.

The French Banking Federation has also highlighted the results of the pilot climate stress test conducted by the French Prudential Supervision and Resolution Authority, which showed that French banks have “moderate” exposure to risks linked to climate change but that they are committed to supporting a responsible transition.

Taking action

With increased regulation and focus on climate risks by the ECB on the horizon, it is clear that eurozone banks need to step up their efforts on disclosure now in order to avoid falling further behind. But it is not just the ECB that is increasing its focus on climate risks; regulators all over the world are doing the same, too.

The US Securities and Exchange Commission (SEC), for example, recently proposed rules that would require public companies (including banks) to disclose extensive climate-related information, such as climate risks, in their SEC filings.

“I think we will see an increasing focus on climate risks as more and more regulators run stress tests for banks, with increasing rigour from regulators around how banks are measuring their exposures, looking for consistency between different banks, but also how they are mitigating those risks,” says Mr Villiers. “We are now seeing the welcome development of regulators starting to look beyond just climate to also assess nature-related financial risks. It is also worth noting however, that disclosure is a useful tool for assessing exposures, but more important is how banks take action on climate mitigation and adaptation in response to the understanding of their risk.”

Taking action is crucial — after all, banks are an important vehicle for the climate transition. “With the Paris Agreement and commitments from COP26, it’s clear there is governmental and public policy support for [addressing] climate change,” says Mr Pfuhler. “But what are the best means to get such agreements to work? It comes down to the banks. Banks have always financed economic transitions, so they can do the same with the climate transition.”