ECB warns most EU banks have no 'Paris' climate plan

Out of the 112 banks the ECB oversees "only a handful of them mention actively planning to steer their portfolios on a Paris-compatible trajectory", ECB executive board member Frank Elderson wrote in an accompanying blog.

"Fewer than half of them have taken any steps at all to adjust their business."

Two-thirds of the banks have integrated a form of climate risk assessment into their credit deliberations, but banks will need concrete phase-out plans to steer away existing investments in fossil fuels as well.

"Banks urgently need to set ambitious and concrete goals and timelines to mitigate their exposure to current and future [climate and environmental] risks," Elderson wrote.

He warns bank chiefs should not fall into the trap of waiting for the right moment to act because the "prudential" moment to act has already arrived. "The message of today's report is clear: the time for action is now."

Last week, the ECB reported that 2021 was already one of the most expensive years for extreme weather events.

Although extreme floods, such as the one that hit the Ahr-valley in Germany and Belgium and the Netherlands, are visible examples of climate and environmental risk, with damage expected to cost up to €10bn - climate shocks can impact the financial system in a variety of ways.

So-called "transition risks", or stranded assets, stem from investments in companies that will become obsolete once people shift to sustainable alternatives. Coal assets, or extensive gas infrastructure, can pose such a risk.

The 29 largest energy-suppliers in Europe and the UK risk a potential loss of investment amounting up to €114bn, EUobserver recently reported.

Another way climate change can pose a risk is through environmental degradation and loss of biodiversity.

A recent study by the Central Bank of the Netherlands (DNB) found that Dutch financial institutions are exposed to €510bn in risk from companies dependent on ecosystem services and biodiversity.

'Green Swan' event

Extreme environmental or climate-induced shocks can also cause a global financial crisis.

Covid-19 is an external shock that, like climate change, is "related to a change in our ecosystem" and has been described by the Bank of International Settlements (BiS) as a "green swan event" in a report published in January 2020.

Green finance will need to prevent these risks from materialising.

However, "integrating climate-related risk analysis into financial stability monitoring is particularly challenging because…traditional backwards-looking risk assessments cannot accurately anticipate the form that climate-related risks will take," the BiS wrote in its report.

According to Elderson and the ECB, banks will need to move to a planned phase-out of fossil fuel investments.

The ECB plans to do a EU-wide stress next year, which will look at the carbon intensity of outstanding loans and the supervised banks' ability to withstand financial outfall from environmental or climate change shocks.

Banks that perform poorly in the stress test may face higher capital requirements.