ECB to begin work in 2022 to add climate risk to capital bar

Bloomberg

European bank regulators are set to start work later this year on adding climate-change risks to the framework for setting capital requirements, in a shift that would penalise lenders for failing to prepare for losses from extreme weather and the shift to clean energy.
Several members of the European Central Bank’s (ECB) supervisory board say they expect to begin discussions in the second half of 2022 once they’ve received results from an ongoing climate stress test and
accompanying review. Determining the methodology is likely to be contentious and take until next year or beyond, the people said, meaning a new approach to setting individual requirements could still be several years away.
This month, the ECB began the most detailed study to date of the losses banks could face from climate change, and called it a “learning exercise” for the industry and regulators alike. Requiring banks to broadly assign more capital on the basis of climate risks would represent a major shift in the way regulators seek to prevent financial-sector blow-ups, and has been lobbied against by the industry.
Yet the uncertainty over how fast the planet will warm in the coming decades and still-scarce data on climate impact on many banks’ balance sheets has regulators preparing for difficult discussions, said the officials. They expect stark divisions among officials on how hard to push banks, they said, given that the process relies on patchy data and incomplete methodology.
The central bank is also conducting a thematic review on how banks are incorporating climate into their wider operations including governance and risk management.
Climate issues remain high on the ECB’s list of priorities, even as the war in Ukraine poses the threat of near-term losses for banks if an economic downturn materializes. Irene Heemskerk, head of the Frankfurt-based central bank’s climate center which seeks to cover the impact across policy areas, said that the war isn’t
influencing the agenda so far.
One possibility would be to give banks scores that would be factored into their respective capital requirements, according to the regulators Bloomberg spoke to. That could reflect both the volume of their loans to borrowers who face climate issues, as well as the lender’s preparation in terms of financial reserves and ability to detect and manage risks, they said.
Banks have to comply with minimum capital requirements set for the wider industry as well as an additional buffer which the ECB tailors for each individual lender based on the risks the firm takes.
Translating the scores into bank-specific requirements will probably prove the most controversial issue for the board because it could penalize institutions that lend to Europe’s industrial backbone, said the regulators. There’s also concern about inadvertently pushing banks to cease giving credit to homeowners or companies in certain areas such as coastal
regions, the officials said.
Euro area officials are already beginning to weigh in publicly. Francois Villeroy de Galhau, the head of the Bank of France, said that methods need to be fine-tuned and “capital add-ons” should only be considered once climate risks are “properly evaluated.” Galhau is a member of the ECB’s Governing Council and one of his deputies sits on the supervisory board.
The European Central Bank has previously said there won’t be a direct effect from this year’s stress test on the capital requirements banks face, but that climate will eventually be treated as other risks.