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- Significant progress made: Over 90% of euro area banks now consider themselves materially exposed to climate and environmental (C&E) risks—up from just 50% in 2021.
- Supervisory action ongoing: The ECB has issued binding decisions and potential penalty payments to banks failing to meet key deadlines for integrating C&E risks into strategy, governance, and capital planning.
- Final push ahead: As the 2024 deadline nears, the ECB will publish an updated set of good practices and begin informal dialogues for 2026 transition planning requirements.
European banks have made notable progress in identifying, managing, and mitigating climate and nature-related risks, according to Frank Elderson, Vice-Chair of the ECB Supervisory Board. However, he cautioned that more work is needed to apply best practices across all exposures, portfolios, and risk types.
“In 2019, less than a quarter of euro area banks had assessed the impact of global heating and biodiversity loss on their risk profile. Today, most have significantly stepped up,” Elderson wrote. “Thanks to the hard work of climate risk experts, risk managers, and internal auditors across all types of institutions, the banking sector has evolved meaningfully.”
Yet Elderson emphasized that sound practices are too often limited to a narrow subset of exposures or geographic areas. For example, many banks address transition risks in collateral valuation but overlook physical risks such as floods or heatwaves. Similarly, C&E risks are better integrated in credit risk than in operational or market risk.
Supervisory Expectations and Penalties
Following the 2022 climate risk stress test and thematic review, the ECB set a series of deadlines:
- March 2023: Banks were required to implement sound materiality assessments. The ECB issued 28 binding decisions, 22 of which included potential periodic penalty payments (PPPs).
- End-2023: Banks were expected to embed C&E risks into governance and risk management. Only 9 banks received further binding decisions for failing to meet expectations.
- End-2024: Banks must fully integrate C&E risks into stress testing and ICAAPs. The ECB is finalizing its assessment, with signs of substantial improvement.
“Encouragingly, not only are foundational weaknesses decreasing, but we also see more advanced practices emerging,” Elderson noted. “Over 90% of banks now consider themselves materially exposed to C&E risks—an increase from just half in 2021.”
Stress Testing and Capital Planning Still Incomplete
While all banks have now included climate risk in their stress testing frameworks—a leap from 41% in 2022—gaps remain. Many do not account for all material risk drivers, portfolios, or transmission channels. Moreover, nature-related risks remain largely unaddressed.
“Three-quarters of banks still do not cover all material climate and nature-related risk drivers in their ICAAPs,” Elderson warned. “Only a third explicitly integrate climate-related risks into capital plans.”
He added that risk underestimation remains a key concern due to methodological limitations, particularly in the modelling of compounding events and tipping points.
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Rising Physical Risks and Systemic Implications
Elderson underscored the urgency of action by citing accelerating climate impacts:
- Floods in Valencia
- Heatwaves across Europe
- Wildfires near Marseille
He also referenced warnings from Allianz that escalating global temperatures could eventually render insurance markets unviable, posing “a systemic risk that threatens the very foundation of the financial sector.” Swiss Re’s sigma report projects a 5–7% annual increase in insured losses from natural catastrophes.
“These are not theoretical risks—they’re material and mounting,” Elderson emphasized.
Data, Disclosure, and Policy Alignment
The ECB called for careful calibration in simplifying the EU’s sustainable finance reporting framework. Elderson argued that excluding too many firms from the Corporate Sustainability Reporting Directive (CSRD) could jeopardize vital data availability.
“To preserve the integrity of risk assessments, our ECB opinion supports the inclusion of medium-large firms (500–1,000 employees) under proportionate disclosure rules,” he said.
Transition Planning Requirements Ahead
European banks are well-positioned for the 2026 prudential transition planning requirements, as most elements are already embedded in supervisory expectations. The ECB will take a phased approach:
- 2025–2026: Informal dialogues with banks to evaluate progress and challenges.
- 2027: Formal assessments begin.
“Where persistent shortcomings exist—especially around comprehensiveness and geographical coverage—Joint Supervisory Teams will raise these with banks,” Elderson said.
Next Steps: Updated Good Practices and Industry Engagement
To support banks, the ECB will publish an updated compendium of good practices later this year, building on insights from prior climate stress tests and thematic reviews. The ECB will also host an industry outreach conference on 1 October 2025 to share progress and address ongoing challenges in climate-related risk management and capital planning.
“In the face of systemic climate and nature risks, only resilient banks can finance the green, digital, and defence transitions we need to safeguard our way of life,” Elderson concluded.
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