Bank Pulse: ECB findings show banks should take more action on climate risk disclosures

It is no secret that the European Central Bank (ECB) sees climate change and environmental degradation as one of the main challenges the banking sector will face in the years to come. This has led the central bank to increasingly emphasise the importance for banks to effectively manage climate-related and environmental risks, and to become more transparent on these risks in their disclosures. Last week, the ECB concluded once again that banks still have some work cut out for them to bring their disclosures in line with the supervisory expectations.

The ECB’s guide on climate-related and environmental risks of November 2020 is a key element of the central bank’s ongoing supervisory dialogue with banks on climate risks. While the guide is not binding, it does describe how the ECB expects banks to consider climate-related and environmental risks within their business strategy, governance and risk management frameworks. It also explains how credit institutions should become more transparent via their climate-related and environmental disclosures. Moreover, the ECB does intent to ultimately integrate climate risks into its Supervisory Review and Evaluation Process (SREP).

On 14 March 2022, the ECB published its second report on the climate-related and environmental risk disclosures of European banks. The report offers insight into the progress made by banks in terms of offering transparency on their climate-related and environmental risk profiles, since the first review of November 2020.

The report follows the ECB’s supervisory review on the state of climate and environmental risk management in the banking sector of November 2021. Based upon a self-assessment by 112 significant institutions, the ECB back then evaluated the steps taken by European banks to manage climate and environmental risks with reference to the ECB’s guide. While banks already made good progress, the ECB concluded European banks still had a long way to go to fully align their practices with the ECB’s supervisory expectations.

In light of the outcome of last year’s supervisory review, it may not come as a surprise that the ECB also in its most recent report came to the conclusion that virtually none of the banks disclose all the basic information on climate-related and environmental risks in line with all of the ECB’s expectations. In fact, for 45% of the banks the ECB believes disclosures to be insufficient from both a content and substantiation perspective.

That said, the central bank did see some improvement in the disclosures. For instance, 71% of the credit institutions did describe the processes in place for identifying, assessing and managing climate-related and environmental risks. This compares with 57% in November 2020 when the ECB published its first report on climate-related and environmental disclosures for the year 2019. Also, 71% of the assessed banks now explain how their board oversees climate-related and environmental risks, compared to 55% in 2019. Besides, 41% of the banks do describe the impact of transition risk on their strategy, compared to 30% in 2019. This percentage is made up of banks that disclose the strategic impact of both physical risk and transition risk (31%) and banks that only disclose the impact of transition risk (10%). It excludes the 2% of banks that refer to physical risks alone.

The ECB also found that only 15% of the banks disclose Scope 3 financed emissions, even though almost three-quarters of the banks provide information on Scope 1, 2 and 3 emissions. Stepping up on these disclosures will be crucial for banks, considering the fact that part of the banks (those with traded securities) are required to disclose Scope 3 financed emissions in light of the EBA ITS on Pillar 3 disclosures on ESG risk. The same holds when it comes to disclosures on the energy efficiency of real estate collateral, where the EBA ITS require banks to provide information on the collateral distribution by EPC label and energy consumption. The ECB concludes that 80% of the banks do not yet provide this type of information. Importantly, the ECB also found that little over 25% of the banks made some qualitative reference to the EU taxonomy in their disclosures, while only 7% provided quantitative information relating to the taxonomy.

The outcome of the ECB’s most recent review of the climate-related and environmental risks disclosures of European banks confirm that transparency on these risks will remain an important topic within the central bank’s supervisory dialogue with banks. Further aligning their disclosures with the ECB’s expectations should also help banks prepare for the far-reaching regulatory (Environmental, Social, and Governance) ESG disclosure requirements, while at the same time offering market participants better possibilities to analyse the banks’ ESG risks and efforts.