European Banks Urged to Accelerate Adoption of ESG Risk Strategies

European Commission report finds most European banks are failing to highlight, measure and report on their ESG risks.

Most banks in the European Union have failed to adopt ESG risk strategies and must up their game in order to meet Paris Agreement targets.

A new report from the European Commission (EC) into the integration of ESG factors into the EU banking prudential framework and the business strategies and investment priorities of banks, revealed that only a few institutions had an “explicit and comprehensive” ESG risk strategy in place.

In addition, a common definition of ESG risks did not exist in the European banking sector and measurement of exposure to ESG risks was very limited.

As a result, the EC stated that banks had to accelerate their ESG policies, set public targets and could be faced with compulsory adoption of EU standards.

ESG mapping

The report, authored by BlackRock Financial Markets Advisory, found that few banks had adopted a detailed list of ESG factors with a mapping to specific sectors, geographies and client segments in order to understand their relevance as drivers of risk. They had also not yet developed a clear mapping of how different ESG factors feed into financial risk types.

It said that banks had made progress on climate-related risks but that other ESG risks tended to be “viewed through the lens of reputational or strategic risk”.

In terms of measurement, it found that banks do not embed ESG risks into ‘business as usual’ practices and that the current degree of ESG integration in banks’ risk management processes needed improving.

‘ESG factors are widely, albeit superficially, integrated within lending policies, credit application processes and due diligence,” the report said. ‘However, coverage is often limited, and off-balance sheet investment activity associated with advisory, or debt capital markets is often not in scope.”

Reporting shortfalls

Another key finding was that banks have not integrated ESG risks within their internal risk reporting frameworks. The report said that disclosures by banks tend to be qualitative with further development needed to reach international and upcoming regulatory standards such as the planned  Corporate Sustainability Reporting Directive.

Only a few banks, it added, had evolved their offering of ESG-related products and services, such as green bonds and green project finance. In addition, while most banks state that they are planning to integrate ESG factors into their lending and investment activity, adequate monitoring and targets, such as Paris Agreement goals, was lacking.

Most banks have also failed to collect comprehensive evidence on the risk/return profile of their ESG lending and investment activities.

Prudential supervisors fared little better with the report stating that there was no common ESG definition among supervisors or quantified indicators for the measurement of ESG risk.

Despite this, central banks and other prudential regulators across Europe are monitoring the climate risks of banks more closely, with a number imposing stress tests to assess banks’ exposures to both the physical and transition risks associated with climate change.

Possible solutions

The EC said more cross-bank collaboration was needed to boost effective ESG integration. Banks and supervisors should work together to develop coherent definitions of ESG risks and a common framework for the understanding of them.

As part of this they should also talk to civil society organisations for a more balanced perspective.

Banks are also encouraged to develop “ambitious, publicly stated ESG risk strategies with measurable objectives, priorities and timelines” and make significant efforts to enhance data quality, availability and comparability.

Approaches to measure exposure to ESG risks, such as stress testing and scenario analysis, should be further refined through more market collaboration and the development of dedicated methodologies.

In addition, to harmonise ESG product classification, compliance with certain standards and regulatory frameworks, such as the EU Green Bond Standard or the EU Taxonomy could be made compulsory to “mitigate the risk of greenwashing”.

Measures aimed at increasing accountability at executive and board level could also be introduced such as aligning ESG strategies with international agreements and initiatives.

The report adds to pressure on banks, not just in the EU but around the globe, to do more to combat climate change ahead of COP26.

In April, 43 global banks launched the Net Zero Banking Alliance (NZBA), members of which are committed to setting 2030 and 2050 targets within 18 months. The NZBA is part of a wider umbrella organisation – the Glasgow Financial Alliance for Net Zero – which is expected to provide an update on finance sector alignment with the Paris Goals at the Glasgow Summit.

Last month (July) a group of investors representing US$4.2 trillion in assets under management, including Aviva Investors and M&G Investment, wrote to banking giants such as HSBC and JP Morgan to strengthen their climate and biodiversity strategies.

This included a call for them to publish short-term climate related targets covering all relevant financial services ahead of their 2022 AGMs and integrate net zero scenarios into their climate strategies.



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