Climate risks for banks: management is improving, but there is still room for progress

Climate and environmental risks have now become a real threat that all companies must address urgently. “Since 2019, banks have significantly stepped up their efforts. At that time, less than a quarter of banks in the euro area took into account how global warming and biodiversity loss affected their risk management ” said Frank Elderson, member of the Executive Board of the ECB and Vice-Chairman of the ECB Supervisory Board, on the ECB's blog. “Today, many already have advanced practices in place to identify, monitor, and, most importantly, manage these risks.”

Banks and climate risk

The risks arising from climate change and the biodiversity crisis have increased in intensity and frequency over the last decade. As highlighted in the latest Global Risks Report, produced annually by the World Economic Forum, extreme weather events are currently the second biggest concern for businesses. Furthermore, looking ahead 10 years, environmental risks fuel the four main concerns of businesses: extreme events, ecosystem collapse, critical changes in terrestrial systems, and resource scarcity.

EU banks have gradually improved their management of environmental risks. In 2022, 25 percent of banks in the European Union paid no attention to these risks, while 54 percent had only some basic practices in place. By 2024, these percentages had fallen to 5 percent and 17 percent, respectively, while 56 percent of institutions had some advanced and well-established practices in place, according to ECB data.

In recent years, the ECB has made it mandatory to conduct materiality assessments and include climate risks in stress tests. “Today, more than 90% of banks consider themselves to be materially exposed to climate and environmental risks,” added Frank Elderson.

Even so, the ECB official points out that recent assessments often show that banks’ current good practices only cover a subset of exposures, not all risk categories or all geographical areas. Most progress has been made in covering climate risks in credit risk analysis, but there is still much room for improvement, such as operational risk and the inclusion of physical climate change risks in mortgage collateral valuations.

How can climate risk management be improved in banking?

Climate change and biodiversity loss are already a reality, as evidenced by recent phenomena such as the DANA in Valencia and Castilla La Mancha in 2024 or the recent heatwave in Western Europe. Insurers have been warning for years that systemic risks could destabilize the financial sector. In addition, banks must deal with the physical risks caused directly by climate change, and also the risks resulting from the transition to a low-carbon economy.

Given this scenario, the ECB official highlights the importance of three measures to mitigate the impact of risks in the banking sector:

1. Include environmental risks in stress tests and capital assessments. Much progress has been made in this area over the past three years, but some remain to be included, such as nature-related risks.
2. Collect and analyze reliable data to accurately identify risks and opportunities and comply with sustainability reporting obligations under the European directive (CSRD).
3. Planning the green transition. Under the revised Capital Requirements Directive (CRD VI) a new legal requirement is introduced for banks to address the environmental and climate risks arising from the adjustment process toward climate neutrality by 2050.

“European banking supervision will continue to work toward a sector that is resilient to the climate and biodiversity crises. Only resilient banks can finance the green, digital, and defense transitions that Europe needs,” concluded the member of the ECB’s Executive Board and Vice Chair of the ECB’s Supervisory Board.