The ECB report concludes that while banks have disclosed more information on climate and environmental risks over the past year, the quality of this information is still insufficient to meet the new regulatory standards. Nevertheless, the standards achieved so far within the EU are higher than those of comparable non-EU institutions.
These standards build on the Taxonomy Regulation adopted by the European Commission in 2021. In 2022, the Corporate Sustainability Reporting Directive (CSRD) made this more specific and more stringent, particularly with regard to disclosure requirements and sustainability reporting. The review is also due in part of the fact that by the end of June 2023, European banks must comply with tighter EU rules on disclosures of climate and environmental risks under the implementing technical standards (ITS) on Pillar 3 disclosures. The ECB’s assessment focuses on the existence, justification and soundness of the banks’ disclosures.
In detail, the report comments as follows:
Materiality assessment
Some 86% of banks consider their exposure to C&E risks to be material. This represents an increase, as this assessment was 80% in 2022 and as low as 50% in 2020.
However, the quality of the disclosures remains insufficient. Currently, only 11% of banks would sufficiently meet the quality requirements.
Business model
With regard to business models, the report concludes that only 32% of banks satisfactorily describe the potential strategic impact of both transitional and physical risks. It states that some 60% of institutions either incompletely or inadequately consider C&E risks in their business models. The vast majority of banks only give high-level consideration to these risks and do not consider the potential impact on their business model. As a result, it would not be possible to analyze how transition risks affect the business environment or which counterparties and products are particularly affected by them. In addition, the impact of transition risks on the institution's balance sheet would not be apparent, and stakeholders would not have a sufficient overview of relevant risks.
Governance
About one-third of banks have adequate governance structures and arrangements in place with respect to climate and environmental risks, including adequate oversight by their governing body and participation by the executive board. However, most institutions lack the necessary information on the frequency of reporting to their respective executive board.
Risk management
Some 85% of institutions disclose at least minimal information on their procedures for identifying, assessing and managing climate-related and/or environmental risks.
However, only 17% do so in a way that allows stakeholders to understand how the elements of C&E risks have been integrated into the risk management process in terms of interconnections, temporal horizon, proportionality and consistency.
The ECB criticizes the fact that in most cases, the identification of climate and environment-related risks is insufficient. The report particularly notes a lack of discussion of clear relationships between financial and non-financial risks and climate-related risks. Furthermore, 56% of banks do not disclose which key risk indicators are used for monitoring and managing C&E risks.
Other environmental risks
The ECB report recommends that banks pay more attention to other environmental risks, such as biodiversity, as most institutions do not currently take these risks into account. In 2021, only 25% of banks referenced other environmental risks, which has only slightly improved to 35% in 2022.
In its report, the ECB compares the standards of the largest EU-based and non-EU-based banks (global systemically important institutions – G-SrIs). Although the EU-based G-SrIs do not yet fully meet regulatory expectations, they are already performing better than comparable non-EU-based G-SrIs.
The ECB urges the institutions concerned to make further improvements and has already informed them directly in this regard. As guidance, the report provides examples of best practices to align the disclosure of information with supervisory expectations. It also announces further supervisory measures to help ensure compliance with the new standards. A first review of progress is scheduled for the second half of 2023.
Client Alert 2023-109
