The European Central Bank’s banking regulator criticizes the financial sector for its careless handling of credit risks arising from climate change. “The economy needs stable banks, especially during the green transition,” said the deputy head of the banking regulator, Frank Elderson, in a post published on Tuesday. For banks, in turn, it is crucial to identify and measure the risks arising from the transition to a decarbonized economy. “Transition planning must become a cornerstone of standard risk management because it is only a matter of time before transition plans become mandatory,” writes Elderson.
In recent months, the Dutchman has repeatedly called on banks to re-examine their lending from the perspective of climate risk. A current ECB study on the lending practices of the 95 most important financial institutions in the monetary union, which was published on Tuesday, underlines the urgency. According to this, the loan portfolios are “significantly not in line with the goals of the Paris Agreement”. This leads to “increased transition risks” for around 90 percent of these banks.
In addition, around 70 percent of these banks could be exposed to an increased risk of litigation “since they are publicly committed to the Paris Agreement, but their loan portfolio is still not measurably aligned with it,” Elderson summarized the results of the analysis. According to the ECB, the financial institutions examined account for three quarters of the loans in the euro zone.
The Paris Climate Agreement of 2015 stipulates that global warming should be limited to 1.5 degrees compared to the pre-industrial era in order to prevent the worst consequences of climate change. Europe’s banks still grant too many loans to companies that produce products that are harmful to the climate. This results in risks of loss. For example, if an institution grants loans to the tourism sector in regions where flooding is more likely to occur in the future. Or when the bank provides loans to a company that no longer has a business model “overnight” due to its climate-damaging orientation, be it because customers are leaving or because politicians have decided on stricter rules.
The banking sector must have quantified the credit risks from climate change by the end of the year and report them to the ECB. If the requirements are not met, the supervisors could also demand more capital from the banks in the future. Negotiations on the amount of the risk buffer are ongoing.