The European Central Bank (ECB) issued a new warning to lenders stating that their failure to respond to financial risks emerging from climate change in the next two years will have serious ramifications, such as an increase in capital requirements and imposition of fines. The ECB wants banks to include climate risks in their “governance, strategy and risk management” by the end of 2023 and meet all supervisory expectations by the end of 2024. This move comes as the ECB has recognised shortcomings in efforts taken by banks to address climate risks.
Results of the ECB's thematic review revealed that banks significantly lag behind in managing climate and environmental risks. The review found "blind spots" at 96 per cent of the banks in identifying risks.
Frank Elderson, vice-chair of the ECB's supervisory board, stated in a blog: "Most banks have thus not yet answered the question of what they will do with clients who may no longer have sustainable revenue sources because of the green transition. In other words, too many banks are still hoping for the best while not preparing for the worst."
There are clear regulatory expectations from banks and firms to further their green agendas and ramp up efforts to understand climate risks better. ECB’s move here reflects these expectations.
Climate Risk and its Impact on Banks
These regulations come against the backdrop of increased financial risks stemming from climate change as Chief Risk Officers have asserted that climate change is the biggest emerging risk they face today. The major climate risks faced by banks are: