European banks' risk management practices still leave much to be desired, particularly in terms of climate-related and environmental risks, European Central Bank supervisory board member Kerstin af Jochnick told a conference Sept. 8.
The ECB's ongoing review of the sector's alignment with supervisory expectations for climate risk management shows that most of the banks "still have a long way to go," af Jochnick said in a speech at the Handelsblatt Banking Summit 2021.
"In some cases, where banks are extreme outliers, the ECB will impose qualitative supervisory measures as part of the 2021 Supervisory Review and Evaluation Process. A full supervisory review will be conducted in 2022," af Jochnick added.
In 2021, European regulators have cranked up pressure on banks to assess and map climate risks in their portfolios, with the European Banking Authority proposing new technical standards to measure the sector's transition to sustainability, including a green asset ratio.
In its first EU-wide review of banks' climate risk assessments in May, the EBA found data gaps and big differences in the application of the EU taxonomy for sustainable activities and concluded that there is a need for more disclosure on transition strategies and greenhouse gas emissions "to allow banks and supervisors to assess climate risk more accurately."
Bank executives attending the conference, including Deutsche Bank AG CEO Christian Sewing and Commerzbank AG CEO Manfred Knof, reiterated their organizations' and the sector's commitment to the transition to a greener economy. "The fight against climate change is probably the greatest challenge facing humanity, and we banks will have to fundamentally align ourselves with it," Sewing said. "Sustainability is already changing banks fundamentally — and this change will accelerate even more," he added.
For critics, however, the change is not fast enough. Regine Richter, a campaigner from environmental organization Urgewald, said at the conference that banks are dragging their feet when it comes to reducing financing to carbon-intensive sectors, referring to a recent Urgewald study that found little change in banks' financing for large coal companies.
No room for complacency
Another area in which the ECB found European banks are still lagging is managing credit risk, a f Jochnick said. A recent in-depth review by the supervisor found a mixed picture in credit risk management practices across the sector. Some banks have improved their measurement systems in the past year and are "doing pretty well," but there are still many institutions that "need to work more and harder on making sure that they have good insight into the risk they have in their balance sheet," a f Jochnick said.
European banks should also actively manage risks coming from cyclical and structural vulnerabilities, which the sector was facing even before the coronavirus pandemic, the ECB director warned.
The prolonged low interest rate environment has created a need to search for yield, leading to an increase in asset values across equity markets and "ever more complex credit products," and that exposes banks to risks coming from a potential abrupt correction in asset prices, she said. To guard against this risk, the ECB will continue its scrutiny of banks to make sure that "their systems are up to standard," af Jochnick said.
Banks and their supervisors should not be "lured into a false sense of security" just because the sector has managed the COVID-19 crisis well so far. "Past success is not a guarantee for future performance," af Jochnick said. The ECB is still concerned about a potential surge in nonperforming loans after government support schemes imposed due to the pandemic are rolled back.
Beyond that, European banks struggle with persistently low profits and are yet to find "sustainable future-proof business models," af Jochnick said. Digitalization and further consolidation in the sector should help banks cut costs and become more competitive against "newly-licensed providers" in the financial services sector.
On their part, regulators and policymakers must make sure that vital reforms that will help the sector consolidate and become safer are implemented timely and consistently, according to af Jochnick. She highlighted the finalization of the Basel III capital requirements and the European Banking Union as key areas of focus in the near term.
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