Most ominous
Elderson signals that the first climate fines are coming soon
In a Supervision Blog post on 8 May, SSM Vice-Chair Frank Elderson reported on banks’ progress on managing climate and environmental (C&E) risks. With Elderson in the lead, the ECB has pressing banks in recent years to integrate C&E risks into their overall risk management frameworks, on the basis that climate risk is an important driver of several types of financial risk (see my previous posts here and here).
Most have done well
Elderson reported that most ECB-supervised banks have “made significant strides” toward meeting the ECB’s first requirement in this field: to thoroughly and credibly assess how material is the impact of climate change on their businesses and portfolios. As Elderson reminded his readers, the ECB initially required banks to complete this materiality assessment by March 2023. When several banks did not comply, the ECB took increasingly tough enforcement action. This culminated late last year in decisions to impose periodic penalty payments (PPPs) on 18 banks if they did not meet a new deadline. As I described before, under PPPs banks have to pay a fine for every day that they remain non-compliant with the ECB’s requirements.
The good news from Elderson last week was that following this intervention “banks’ materiality assessments are becoming more robust. Most banks now submit a meaningful overview of material C&E risk exposures”. Some have even begun allocating capital to cover the risks they have identified.
Most – but not all
Yet despite this progress, there remain some laggards. Elderson wrote that the ECB has found some banks’ materiality assessments still to be inadequate – either because they are too limited in scope (encompassing only certain geographies or risk types), use net instead of gross calculations (factoring in mitigating actions before assessing the risks) or insufficiently forward-looking (which Elderson argued would inevitably lead to risks being underestimated).
This reads like a strong hint that some at least of the 18 ‘PPP banks’ have not done enough to satisfy the ECB, and should expect to be fined. The ECB has not yet announced any sanctions relating to C&E risk management, nor has it disclosed details of the process for triggering daily fines. (For example, it has not revealed the deadline(s) it set each bank, or whether activating the PPPs will require a formal Supervisory Board decision in each case.) But Elderson’s latest blog suggests we will not have long to wait.
Coming next: E as well as C
Elderson also emphasised that even for banks who have successfully assessed and begun to manage climate risk, there is more to do. Environmental risk, he noted, extends beyond ‘just’ climate change to encompass broader “nature-related risks” such as biodiversity loss and water scarcity. Again, Elderson noted that some frontrunner firms have taken “concrete steps” to assess and quantify these. That is just as well, as Elderson reminded banks that the ECB’s “supervisory expectations explicitly cover also environmental risks”. Repeating a phrase he has used several times before, Elderson stated that ignoring these risks is “no longer compatible with sound risk management.”
Banks - even the “most” who have met supervisors’ expectations so far - should expect no let-up in pressure from the ECB to fully account for climate and environmental risks.
Sidebar: Resilience is the watchword
Also this week, the ECB published Supervisory Board Chair Claudia Buch’s statement to the Eurogroup on 13 May. In line with her previous comments this year, resilience was Buch’s key theme (the words resilience and resilient feature 23 times in just over 7 pages). Resilient banks are beneficial to society; recently European banks have shown resilience to multiple shocks; resilience has many dimensions; and strengthening resilience requires banks to look forward for new or emerging risks.
Buch’s statement was thus a reminder that resilience is central to her thinking and supervisory approach. It is a theme I will dive deeper into in a future post.