The European Central Bank (ECB) announced the release of its updated compendium of good practices for climate and nature-related risk management and stress testing, aimed at supporting banks in strengthening their risk management practices in challenging areas such as nature-related risks, transition planning and physical risks.
In a blog post introducing the new publication, ECB Executive Board Member and Supervisory Board Vice-Chair Frank Elderson said that while banks have improved their practices for managing climate and nature-related (C&N) risks in recent years, more progress is still needed particularly in areas such as measuring physical and nature-related risks, which he said “are still in their infancy with risks very likely being underestimated.”
The release of the new good practices guide follows the announcement by the ECB earlier this year of a series of new priority areas to advance its work on embedding climate and nature-related risks into its activities, including plans to intensity its work in areas including assessing banks’ green economy transition plans and on analyzing their capabilities to address risks related to the growing physical impacts of climate change.
At the time, the ECB warned that “the economic and financial consequences of climate change and nature degradation continue to grow,” and said that as part of its efforts to continue embedding climate and nature into its work, it will intensify its work with a focus on priority areas including the transition to a green economy, coping with the growing physical impacts of climate change on the economy and the financial system, and the impact of nature-related risks and ecosystem degradation.
In his new blog post, Elderson similarly warned that “we are heading towards a disorderly transition scenario with higher uncertainty,” making it crucial for banks to become “resilient and prepared for a range of possible scenarios – including higher and faster-moving transition and physical risks.”
Elderson said that the new compendium, aimed at helping banks close gaps in their risk management frameworks, draws on good practices approaches that are being applied by more than 60 institutions, with a particular focus on areas in which banks typically struggle, including quantifying physical risk, as well as prudential transition planning, scenario analysis and nature-related risks.
Key good practices highlighted by Elderson in the area of prudential transition planning, which “supports banks in understanding how different plausible transition pathways can affect their risk profiles,” include a focus by banks on helping companies in hard-to-abate sectors to shift to low carbon technologies by designing transition finance products and strategies, “rather than abandoning the relationship with clients in these sectors,” as well as the use of active engagement strategies with corporate clients in high physical risk sectors, and the tolerance for short-term low margins or the use of pricing incentives for specific transition technologies that don’t yet meet profitability targets.
In his blog post, Elderson highlighted key good practices by banks in the area of prudential transition planning, such as the development of transition finance products and strategies to enable companies in hard-to-abate sectors to shift to low carbon technologies, rather than abandoning relationships with clients in these areas, or the use of active engagement strategies with corporate clients in high physical risk sectors, instead of implementing higher prices or retreating altogether from these sectors. Elderson also highlighted the tolerance for short-term low margins or the use of pricing incentives for specific transition technologies that don’t yet meet profitability targets as a practice that may allow banks “to develop a strong position in a growing market, thereby supporting long‑term profitability.”
Elderson highlighted nature-related risks as “an area where approaches are more in their infancy,” with the updated compendium dedicating around one-third of its new good practices in this area. Key good practices highlighted in the post include the use of proactive client engagement – in areas including data collection, engagement on specific exposures, offering nature‑related financial products or advisory services – as well as the integration of nature-related risks into banks’ internal capital adequacy assessment processes, and the use of publicly available tools and datasets to help banks shift from qualitative assessments to quantitative approaches.
Elderson said:
“Euro area banks have made significant strides in building up their resilience to C&N risks, but the journey is far from complete. The good practices compendium is an effective toolkit for banks to tackle gaps, navigate a challenging and evolving risk environment – and in turn – capitalise on the opportunities offered by the transition.”
Click here to access the ECB’s updated compendium of good practices for C&N risk management and stress testing
