In a new report, the European Central Bank ("ECB") highlighted "good practices" for climate and environmental ("C&E") risk management in the banking sector. The ECB asked 112 institutions to perform a self-assessment of their current practices against 13 supervisory expectations and provide an implementation plan to address these risks.

Among its findings, the ECB observed good practices by the institutions, ranging from "strategy-setting procedures to specific qualitative and quantitative indicators in risk appetite statements, and from materiality assessments to credit risk management." The least amount of progress had been in the areas of internal reporting, liquidity risk management, and stress testing; the ECB noted that none of the 112 institutions was close to fully aligning practices with the outlined expectations. Substantial progress has been made mainly by larger institutions; however, almost all of the institutions assessed have developed implementation plans to address C&E risks.

In its report, the ECB highlighted several "good practices" for institutions to consider. Some of these practices include:

  • utilizing "double materiality" assessments, where institutions consider both financial materiality and environmental materiality;
  • managing C&E risks through qualitative statements and quantitative indicators;
  • integrating C&E risks into reporting practices;
  • including C&E-related criteria in sector and investment policies; and
  • performing stress testing using a defined baseline to assess physical and transitional risks.

The ECB concluded that (i) although institutions have begun making progress, it remains slow; (ii) the ECB recognizes the challenges associated with the integration of C&E risks into "strategies, governance and risk management arrangements [that] are constantly evolving"; and (iii) the ECB expects all institutions to take "decisive action to address the shortcomings" found in the supervisory feedback letter.

Commentary

The ECB report possibly offers a harbinger of what U.S. institutions might expect as the Fed, FDIC and OCC incorporate assessment of institutions' risk management of climate-related financial risk. Though for U.S. institutions, guidance on risk management of climate-related financial risk is more likely to come in the form of principles-based guidance rather than rules-based directives.

Primary Sources

  1. European Central Bank Report: The state of climate and environmental risk management in the banking sector

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