Elderson: European banks have progressed on climate risk, but more action needed

European banks have taken significant steps to measure and manage climate risks, but more work is needed, according to European Central Bank (ECB) executive board member Frank Elderson.

Only 5% of banks had no practices in place at the end of 2024, down from a quarter in 2022, according to an ECB analysis of banks’ alignment with the central bank’s supervisory expectations on climate-related and environmental risks. 

Meanwhile, more than half of banks have adopted leading practices for some climate exposures, up from only 3% in 2022.

“European banks have made significant strides in addressing the risks stemming from the ongoing climate and nature crises,” Elderson said. “But more still needs to be done as we often see that practices are only applied to a subset of relevant exposures, geographic areas and risk categories.

More than 90% of banks currently consider themselves to be materially exposed to climate-related and environmental risks, up from 50% in 2021, with risk assessments becoming increasingly sophisticated, Elderson said.

“Climate and nature-related risks are already a reality, and the materiality of these risks is clearly rising. And thus banks also need to make further improvements in their preparedness,” he said. “The climate crisis is unfolding faster than previously assumed, with impacts materialising at lower than estimated temperatures.”

Elderson noted experts are forecasting climate change will have serious long-term effects on house prices and other asset values. Allianz has warned that more natural disasters might mean that insurers would no longer be able to operate, creating “a systemic risk that threatens the very foundation of the financial sector,” he added.

The ECB is finalising its assessment of which banks met its deadline of the end of 2024 to include climate-related and environmental risks in their stress testing and internal capital adequacy assessment processes (ICAAPs).

The number of banks not meeting the foundational elements has decreased even further, Elderson said, adding that banks under European supervision are well positioned to meet the prudential transition planning requirements that will come into effect in 2026.

However, three-quarters of banks do not yet cover all material climate and nature-related risk drivers in their ICAAPs, and only one-third of banks explicitly integrate climate-related risks into their capital plans.

“Looking ahead, banks must make their ICAAPs more comprehensive to ensure their capitalisation is commensurate with the underlying risk,” Elderson said.

He added that all banks have now included climate risk in their stress testing framework, up from only 41% in 2022.

The ECB plans to publish a collection of good practices observed in banks across Europe later this year and will host an industry conference on October 1.

“European banking supervision will continue to strive for a European banking sector that is resilient to all of the material risk drivers they face, including those stemming from the climate and nature crises,” Elderson said. 

“Only resilient banks can play their vitally important role in the economy, financing much-needed investments in the green, digital and defence transitions so that we can preserve our way of life and remain masters of our own destiny.