• The ECB’s updated compendium draws on practices already used by more than 60 institutions, covering over half of its directly supervised banks.
• The guidance targets weaker areas in bank risk systems, including physical risks, prudential transition planning, scenario analysis and nature-related exposures.
• The ECB warns that banks face a more disorderly transition scenario, with faster-moving physical and transition risks likely to test resilience.

The European Central Bank is pushing supervised banks to sharpen their climate and nature-related risk management, as physical damage, transition policy and ecosystem loss move deeper into financial risk models.

ECB Banking Supervision has updated its compendium of good practices for climate and nature-related risk management and stress testing. The document draws on approaches already applied by more than 60 institutions, representing more than half of the banks directly supervised by the ECB.

The update focuses on areas where banks still show gaps. These include physical risk measurement, prudential transition planning, scenario analysis and nature-related risks. The ECB said the compendium includes practices with different levels of sophistication, so smaller and less exposed banks can also use it.

“Banks have improved their practices for managing climate and nature-related risks in recent years,” said Frank Elderson, Member of the ECB Executive Board and Vice-Chair of the ECB Supervisory Board.

“All banks under our supervision now have the foundational architecture in place to identify, quantify and manage the risks from the ongoing climate and nature crises,” he added.

Progress Is Clear, But Risk Models Still Lag

The ECB said banks have made progress, but it warned that current methods still underestimate key risks. Physical and nature-related risks remain early-stage areas for many institutions. Some bank-specific weaknesses also remain unresolved.

Elderson said the risk landscape is becoming harder to manage because the transition is becoming less predictable.

“We are heading towards a disorderly transition scenario with higher uncertainty,” he said. “It is therefore crucial to be resilient and prepared for a range of possible scenarios, including higher and faster-moving transition and physical risks.”

The ECB stressed that its good practices do not create new legal or regulatory requirements. Banks can remain compliant without implementing the specific examples in the compendium, provided they use other suitable measures for their business model and risk profile.

Still, the update arrives as European supervisors increase pressure on lenders to embed environmental risks into core governance, credit, pricing and capital planning. The EBA Guidelines on ESG risk management and environmental scenario analysis will also increase expectations from 2027.

Transition Planning Becomes A Business Test

The ECB highlighted prudential transition planning as a core tool for banks navigating climate uncertainty. The regulator said banks cannot predict the exact mix of policy, technology and geopolitical pressures they will face. However, they must understand how plausible transition pathways could affect their risk profile.

“The regulation on prudential transition planning is not prescriptive as to what specific decarbonisation pathway banks are supposed to be on,” Elderson said.

Instead, he said banks must think clearly about strategy, set long-term objectives and build effective risk management frameworks.

The ECB pointed to transition finance as one area where banks can turn risk management into commercial opportunity. Some banks are using technical knowledge of high-emitting sectors such as cement, steel and aviation to design financing and advisory products.

“Rather than abandoning the relationship with clients in these sectors, banks can capitalise on the transition,” Elderson said.

That approach allows lenders to support clients moving from high-emission to low-carbon technologies. It can also help banks diversify income and build stronger positions in future growth markets.

RELATED ARTICLE: ECB Publishes Climate-Related Statistical Indicators to Narrow Climate Data Gap

Physical Risk Needs More Granular Data

The compendium also encourages banks to move beyond broad physical risk assumptions. Instead of applying higher pricing across whole regions or sectors, some banks are engaging directly with corporate clients in high-risk sectors.

The ECB said this client-specific approach may be more effective than blanket responses. For example, banks are reviewing how floods, droughts and wildfires could affect clients’ collateral, revenues and debt service capacity.

In scenario analysis, some banks now assess transition risks at the individual counterparty level. They estimate how carbon prices or green investment needs affect a company’s financial ratios. Then they feed these results into internal rating systems to calculate stressed probabilities of default.

Other banks are mapping physical risk exposures to exact asset locations. Some combine hazard maps with client-level data, including water intensity, to create drought risk indices. More advanced models simulate business interruptions from floods or wildfires and translate those impacts into default, loan-to-value and loss-given-default metrics.

Nature Risk Moves Into The Supervisory Frame

Nature-related risks remain less developed. The ECB said most banks have carried out materiality assessments, but around two-thirds do not yet link them systematically to risk management actions.

Only a few banks have defined nature-related key risk indicators. Even where indicators exist, banks often use them only for monitoring, without limits or thresholds that trigger management action.

To support progress, around one-third of the new good practices focus on nature-related risks. These include public tools and datasets that assess ecosystem dependence, biodiversity impacts, protected-area proximity, pollution and water use.

For executives and investors, the message is clear. Climate and nature risk management is no longer a disclosure exercise. It is becoming a test of governance, credit discipline, pricing strategy and long-term competitiveness across Europe’s banking system.

ESG News Editorial Team

The ESG News Editorial Team is comprised of veteran financial journalists and sustainability analysts dedicated to providing real-time, objective reporting on global ESG regulations, climate finance, and corporate governance. Our desk monitors daily developments from the SEC, IFRS, CSRD and international regulatory bodies to ensure our 1M+ readers receive accurate, data-driven insights into the evolving sustainable investment landscape. Follow the ESG News Editorial Team for expert reporting on global sustainability standards, ESG disclosures, and climate policy. Access over 10,000 investigative reports and real-time updates.