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Eurozone banks told to do more to tackle climate change risks

The European Central Bank has asked banks to “urgently” improve plans to protect their businesses from climate change risk after a review found widespread shortcomings in lenders’ approach to environmental challenges.

The ECB, which has directly supervised the biggest banks across the eurozone for seven years, has completed its first assessment of banks’ preparedness to deal with increased climate and environmental risks. It found that no bank under its watch was close to meeting the ECB’s expectations. The central bank said lenders might “eventually” face higher capital demands as it integrated climate risk assessments with its regular work on setting individual banks’ capital levels.

The biggest risks to banks comes from exposure to energy companies that do not pivot to more sustainable activities and energy-intensive sectors such as aviation, according to the assessment. Other risks include lending on buildings which are less energy efficient and therefore may have a lower resale value.

Although banks such as HSBC and Bank of America have introduced their own net zero targets, scrutiny has increased in recent years of the sector’s lending to carbon-intensive activities.

The ECB’s study focused on 112 banks with combined assets of €24tn. Half of those lenders said climate change would have a “material” impact on their businesses over the next three to five years. None of the banks that reported climate risks as “immaterial” had carried out sufficient analysis, wrote Frank Elderson, ECB executive board member and vice-chair of the ECB’s supervisory board, in a blog post.

Other shortcomings highlighted by the ECB included a lack of stress testing to see what would happen to banks’ businesses in various climate change scenarios, and poor planning for how they should make their business models more resilient in the face of climate change. The banks with the biggest shortcomings have been urged to fix them as part of the ECB’s regular supervision.

“Banks urgently need to set ambitious and concrete goals and timelines — including measurable intermediate milestones — to mitigate their exposure to current and future climate and environmental risks,” Elderson wrote.

Sasja Beslik, head of sustainability at Denmark’s largest pension fund PFA and a prominent environmental, social and governance investor, said he did not expect banks to make “major improvements” in their climate risk management strategies “before they have seen financial losses [from lending to unsustainable industries]”.

“Banks are mirroring the real economy; the real economy is not sustainable so the way banks operate is not sustainable,” he added.

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The ECB did find some bright spots. Elderson said two-thirds of banks had made “meaningful progress” in factoring climate risk into their lending decisions, by doing extra due diligence on borrowers’ climate risks or phasing out lending to some of the most exposed industries.

The ECB will publish a report on banks’ climate risk disclosures in the first quarter of 2022 and is planning a broader review on banks’ strategy, governance and risk management around climate change risk in the first half of next year. The review will only announce results for the financial system, not for individual lenders.

In the UK, banks last month submitted data for the Bank of England’s first climate “stress tests”, which the BoE described as “exploratory in nature” with no bearing on capital requirements. Results, which will be presented as aggregate findings for the UK banking system, are scheduled to be published by May.

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