According to the European Central Bank (ECB), most major banks in Europe are failing to adapt their business models to the imminent decarbonization of the region’s economy. As a result, they are exposed to increased financial, reputational, and legal risks. Despite the ECB’s continuous efforts to encourage banks to consider climate factors in lending and risk assessment, lenders have disregarded the warnings and the potential for additional capital requirements.
In a recent blog post, ECB board member Frank Elderson stated that an analysis of 95 banks, which cover 75 percent of euro area loans, revealed that the banks’ credit portfolios are significantly misaligned with the objectives of the Paris Agreement. This misalignment poses transition risks for approximately 90 percent of these banks. The ECB’s report indicates that the banks’ overall credit exposure to sectors such as oil and gas, coal, power generation, automotive, steel, and cement amounts to approximately 189 billion euros ($206 billion), which represents roughly 5 percent of credit extended to firms.
The transition to a green economy poses inevitable risks to banks, says Supervisory Board Vice-Chair @FrankElderson.
— European Central Bank (@ecb) January 23, 2024
Among the surveyed banks, 13 institutions have exposures exceeding EUR5 billion ($5.44 billion) each to the six key transition sectors, which contribute to about half of the total CO2 emissions in the euro area. The ECB has set a deadline of the end of 2024 for banks to comply with its climate disclosure requirements, including disclosing the extent to which their activities deviate from the expected decarbonization pathway. Failure to meet these requirements may result in the introduction of additional capital requirements, as stated by the ECB.
Actions speak louder than words
Elderson stressed the importance of incorporating transition planning into standard risk management practices, as it is inevitable that transition plans will become mandatory in the near future. A significant risk for banks lies in the inconsistency between their stated commitments to addressing climate change and their actual practices. Although many banks claim to take climate change seriously, their actions demonstrate a sense of complacency. Elderson highlighted that 70 percent of these banks could face heightened litigation risks since they publicly support the Paris Agreement, yet their credit portfolios are still noticeably misaligned with its objectives.
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