Frankfurt The banking supervisors of the European Central Bank (ECB) are urging Europe’s major banks to step up their pace when it comes to climate protection. “This year we want to see decisive progress in how banks integrate climate and environmental risks into their risk management,” said ECB Deputy Banking Supervisor Frank Elderson on Friday.
He indirectly threatened the banks that did not meet the expectations of the supervisory authority with consequences: “2022 will be the year in which climate and environmental risks will become an integral part of the daily supervisory work,” he said. These risks would now be an “integral part” of the supervisory talks – and ultimately also affect the banks’ capital requirements.
What Elderson means by this: The ECB banking supervisors set individual capital buffers for each bank, in which certain bank-specific risks are taken into account. These individual capital buffers are called “Pillar 2 requirements”. The parameters that play a role here include factors such as the quality of an institution’s risk management – and thus also the question of how well climate risks are taken into account.
The banks confirm unanimously that they want to accompany the economy in the climate-neutral conversion. From Elderson’s point of view, however, the industry has not yet come very far. “Beyond the formal assignment of responsibilities, we still see little progress at banks in managing climate and environmental risks more actively,” he said. “Even banks, recognizing the importance of such risks, have not reported any procedures to either reduce or manage their risk levels.”
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Elderson urged banks to use “the full spectrum” of risk management tools at their disposal, such as “strategically rebalancing” their portfolios by “adjusting qualitative credit criteria” and determining how big their risk appetite is on climate and environmental risks.
Another area where the ECB believes banks should make progress is in “actively helping” their customers to adapt to or mitigate climate and environmental risks.
The progress of the banks is closely monitored by the ECB: Last year, the banks had to present a self-assessment to what extent they were already implementing the ideas from a guide published by the regulator in 2020.
So far, no institute has been able to meet these requirements. “Banks have reported that 90 percent of their practices fall only partially or not at all in line with ECB Banking Supervision expectations. Let me repeat that: 90 percent,” Elderson said.
The institutes must therefore submit action plans on how they want to improve. “The ECB is following up on the progress the institutions have made with their action plans since last October,” reports an insider. The first financial institutions have now received the questionnaires, as the Handelsblatt learned from industry circles.
A whole new kind of stress test
However, the improvements in risk management that have been called for are only one component with which the ECB intends to anchor climate protection more firmly at banks this year. Another building block is the climate stress test, which was carried out for the first time, in which the ECB supervisors simulate the financial effects of various climate shocks. The questionnaires for the stress test must in March be sent back. The ECB intends to publish the results in July.
The difference between the stress test and the review of risk management is as follows: Risk management is about whether banks are already handling environmental risks organizationally, i.e. in their processes, as the ECB wants them to be. In the stress test, on the other hand, the ECB examines how heavily the institutions are exposed to companies that are vulnerable to climate risks – and what financial losses the banks are threatened with if certain unfavorable climate scenarios occur.
An “exercise to learn”
The fact that the ECB banking supervisors are placing more emphasis on the qualitative aspects of how banks deal with environmental risks than on the potential economic consequences of climate change is probably also due to necessity: it is very difficult for banks and supervisors to claim damage from climate change quantify.
In addition, initial experiences from Great Britain indicate that the climate stress scenarios do not necessarily reveal massive economic threats. The first round of the climate stress test by the British regulator PRA had only a minor impact on banks’ equity, people familiar with the matter told the Handelsblatt. “On average, the stress scenarios weighed on the equity ratio by around 0.2 percentage points,” said an insider.
A spokeswoman for the PRA did not comment. The second round of the climate stress test is currently underway in the UK, and the results of both parts of the exercise are due to be published in May.
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In Frankfurt, some experts consider it plausible that the ECB’s climate stress test will deliver similar results. “There is a discussion within banking regulators about how to avoid the impression that climate change is not an important issue for the financial sector because it is unlikely to have any impact on capital ratios,” says a person familiar with the discussions.
ECB officials keep emphasizing that the upcoming climate stress test will primarily serve as a “practice to learn”. This is also the reason why the supervisors will carry out on-site inspections at a handful of banks to see in practice how the banks deal with the issue of sustainability.
According to financial circles, the supervisors have selected a mid-single-digit number of banks from important countries such as Germany, France, Italy, Spain and the Netherlands. The ECB declined to comment on the information.
What is a “green” loan?
The fact that it is so difficult for banks and supervisors to measure environmental risks is also due to the lack of the necessary data. This is shown in particular by the difficulties faced by financial institutions with the “Green Asset Ratio”, which is intended to make the sustainability of the portfolios more comparable: In future, European banks must – by 2024 at the latest – show how large the proportion of their “green” financing is in the loan book .
The EU taxonomy for sustainability determines which loans can be classified as “green”, albeit in a relatively abstract form. Accordingly, companies with activities that serve one of six sustainability goals of the EU are considered “green”. This includes, for example, climate protection, adaptation to climate change or the protection of ecosystems.
Energy suppliers that produce green electricity are likely to end up on the positive list for “green” commitments. Or car manufacturers who produce low-emission vehicles. At the same time, these initially “green” activities must not hinder any other sustainability goals of the EU. A wind farm, for example, should not pose too much of a threat to migratory birds. This means: There is no blanket “green” industry, only companies for which it is easier or more difficult to obtain the green seal of approval.
But the green asset ratio poses major challenges for financial institutions: they lack the data to be able to classify loans to corporate customers as green at all. Tariq Noori, Head of Group Strategy and Sustainability at DZ Bank, warns: “We don’t yet have the relevant data for many of the specifications from the EU taxonomy. The EU taxonomy is very specific with regard to climate protection – but it goes into so much detail that neither banks nor companies have the data.”
The supervisors across the industry are still operating with estimates: the European banking regulator Eba recently estimated that the green asset ratio across all banks is likely to be just under eight percent. According to Christian Piller, banking expert at the software expert Collenda, banks may operate with approximate values for a transitional phase. “They make assumptions for this, partly on an industry basis.” However, Piller assumes that companies that want to request new loans or extend existing loans in the current year would already have to provide data on their climate risks. “In any case, the banks will request this data.”
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