Each year the ECB publishes its climate and environmental risks guide for banks following a public consultation.
This week we are celebrating the 5th anniversary of the Paris Agreement adoption. With its Green Deal, Europe aims to become the first climate neutral continent by 2050. A goal that cannot be achieved without the commitment of the financial sector.
By “commitment” is meant, in particular, to take into account the extra-financial risk factors that may slow down, negatively impact or lead to a capital loss.
These risks affect the entire financial sector and all types of assets. The Bank of the Netherlands reports that for 2019, 8.8% of mortgage exposures are in flood-prone areas of another jurisdiction, and that around 20% of valued exposures of Dutch financial institutions on stocks and bonds are exposed to regions under extreme water stress.
Are these risks clearly identified by banking institutions, and disclosed to investors? Or are they not disclosed, because not taken into account?
To quote Warren Buffet,
“Only when the tide goes out do you discover who’s been swimming naked”
This is why the European regulatory framework sets publication requirements aimed at communicating key information relating to the capital, risks and exposure to risks of an institution in order to adequately inform market participants. Climate risk statements allow them to have a more aware assessment of physical and transition risks, which improves the understanding of the financial implications of climate change by institutions and investors.
And according to the ECB, banks’ statements on climate and environmental risks remain largely insufficient.
This year, it publishes its guidewhich identifies its expectations vis-à-vis of banks with regard to prudent management and transparent communication of these risks, within the framework of the prudential rules currently in force.
With this report, the ECB strives to provide a snapshot of the level of disclosure of climate and environmental risks in the Countries participating in the Single Supervisory Mechanism (SSM). To this end, it assessed climate and environmental risks based on the disclosures of 107 significant institutions and 18 less significant institutions in 2019.
An assessment which constitutes a baseline for the progress to be made to align with future prudential expectations and which can be supplemented by other relevant publications, such as those of the following bodies: European Commission (COM EU) ; European Banking Authority (ABE) ; Network for Greening the Financial System, NGFS) ; Basel Committee on Banking Supervision (CBCB) ; Financial Stability Board (FSB) ; Task Force on Climate-related Financial Disclosures (TCFD) ; Organisation for Economic Co-operation and Development (OECD).
Two concrete stages will now open between the ECB and the banks.
Early 2021, the ECB will ask banks to self-assess against the prudential expectations set out in the guide, with a view to establishing action plans based on the results obtained.
It will then review the self-assessments and the banks’ plans, then question them in the framework of the prudential dialogue. In 2022, it will conduct a comprehensive prudential review of bank practices, and take concrete follow-up action, if necessary.
In view of the growing importance of climate change for the economy and the growing signs of its financial effects on banks, this next ECB prudential stress test in 2022 will focus on climate-related risks. Further details will be communicated in 2021.
According to the ECB, despite some improvements over the previous year, banks should redouble their efforts to improve their communication by backing it up with relevant quantitative and qualitative information.
Article: Joana Foglia – Source: BCE