The European Central Bank gives banks two years to adapt to climate protocols
The European Central Bank continues to reinforce its pro-climate mechanisms, after the results of the first climatic stress test for banks, published this summer in aggregate form to prevent the market from punishing the differences between entities in this first analysis, which was considered an initial test. This evaluation that was proposed by the ECB in 2020, intended to shed light on how environmental issues affect the balance sheets of financial institutions and how the banks were aligned with the agency’s supervisory expectations.
After analyzing a total of 186 banks with more than 25 billion euros in assets, the European banking supervisor affirms that although good practices have been recognized and generalized, they are still far from reaching those goals it set to identify and manage climate risks and the environment more appropriately. For this reason, it has set a two-year deadline for banks to comply with the recommendations set out in the Guide on Environmental and Climate Risks published in 2020.
This guide aims to In addition to climatic conditions, bank balance sheets take into account other impacts, such as the loss of biodiversity, the strategies to be applied or the evaluation of management and government processes. Along with the review, the banking regulator has published a code of good practices so that the most exposed entities can replicate the methods used by the best-placed ones. And the European Central Bank sets priorities. As far as transition risks are concerned, that of financial institutions stands out as ‘good practices’ that assume climate commitments aligned with the Paris Agreement, which sets the goal of being zero emissions by 2050. Another indication that the ECB wants to involve the sector in its own deed against climate change. Last year it already established it that way in its monetary policy objectives.
An improvable risk measurement
In its review, the ECB has determined that although 85% of banks already apply methodologies in this regard in most areas, they still need more specialization and information on the risks generated by climate change. He has criticized that its implementation is lagging behind At the same time, it shows its concern about the ability of these banks to execute their plans, since in almost all of them (96%) blind spots have been found that prevent them from identifying these dangers to which they are exposed.
To advance in this matter, the banking regulator has established a calendar of milestones that all entities must comply with in general, although it has opened the door to certain exceptions. In this way, by March 2023 all banks must have correctly categorized climate and environmental risks, as well as evaluating the impact they generate on their activities.
By the end of next year, banks should have integrated them into their governance policies, risk management and business strategy. The ECB criticizes that most banks have adopted a “wait and see” approach to how others act, compared to a few who have begun to explain the transition to a low-carbon economy to their clients, although he has highlighted that all the good practices observed “demonstrate how the sector can take advantage of innovation to address challenges”.
Affections to the capital
He criticizes, above all, those who have not set limits to the risks they take in the long term so that their impact is insignificant at the present time. The latest milestone, set for the end of 2024, indicates that banks they must meet all the requirements set out in the guide published in 2020including stress tests and internal capital adequacy assessment processes (ICAAP).
The ECB does not rule out taking “coercive measures” in case the entities do not comply with the established deadlines. In fact, it has already imposed certain requirements on more than 30 banks in the Supervisory Review and Evaluation Process (SREP) that it carries out each year, where climate risks have also formed part of the final score, in order to reflected in the requirements of the Pillar 2 mechanism.
Although in the short term climate risks may be included in that ‘individual generic pillar’ of each entity, in the medium term it is expected that it will have its own write-off in capital.
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