Climate risk: staying with the programme

Frank Elderson goes back to basics on climate change as a risk that banks must manage

ECB Supervisory Board Vice-Chair Frank Elderson told banks again this month to put climate change at the centre of how they run their business. In two major speeches in Frankfurt and Rio de Janeiro, the SSM’s most prominent environmentalist argued that climate risk is an indispensable part of sound risk management.

Climate risk is banking risk

Climate change, Elderson argued, cannot be separated from the traditional risks banks face, such as credit, liquidity, operational and legal risk. Rather, it is a potential driving factor that could intensify all of these classic banking risks.

For example, Elderson explained, credit risk could be heightened by extreme weather events such as floods or wildfires if they either disrupted borrowers’ business – damaging their ability to repay loans – or diminished the value of real estate or other assets pledged as collateral. The same events could also threaten banks’ own operations: Elderson cited examples of IT systems being damaged and safety deposit boxes being washed away by floods. Meanwhile banks perceived as environmentally irresponsible could suffer harm to their reputations or find themselves facing costly lawsuits. And over a longer time horizon, the transition to net zero will radically transform the economy, potentially stranding assets and challenging the viability of carbon-intensive borrowers’ business models.

Banks, Elderson said, must therefore make climate risk an essential component of their approach to risk management. And if they do not, the ECB will make them - through formal supervisory requirements, backed up with the threat of financial sanctions. Indeed, as he reminded his audiences, the ECB has already decided to impose daily fines on some 18 banks if they do not remedy deficiencies in their climate risk policies by a certain deadline.

Respecting boundaries

For all his tough talk, Elderson was careful to respect the limits on the ECB’s responsibilities regarding climate change. He was not calling for banks to ‘divest from carbon-intensive industries,’ he affirmed. And he emphasised that ‘central banks and supervisors are not, and do not intend to be, policymakers in the area of climate and nature. It is governments that are responsible for climate and nature policies.’

Elderson’s explicit recognition of the limits to the role of a banking supervisor contrasted markedly with some of his previous more wide-ranging (and emotional) comments on climate change – such as his ‘Beacons of Hope’ speech from last September. This may be a tacit acknowledgement of criticism that his passionate climate activism risks pushing the ECB to stray beyond its mandate to ensure price and financial stability. In recent months, Elderson has faced a backlash from within the central bank, and had to apologise for comments about ‘reprogramming’ ECB staff to be more supportive of environmental policies.

His narrow focus on climate change as a question of risk management can also be seen as an attempt to anchor the issue more firmly in the core mission of a prudential supervisor. This could both offer the ECB a firmer foundation from which to reject the argument advanced by conservatives (especially in the US) that financial firms should pay no heed to environmental, social and governance factors when making business decisions. It could also provide a stronger legal basis for ECB enforcement action against banks that fail to adequately recognise the economic impact of a changing climate.