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European Central Bank to Examine Banks’ Expose to Climate Risk

The European Central Bank (ECB) will examine large banks’ trading operations as part of its climate stress tests next year.
The ECB, which has not yet disclosed the criteria of its tests. It is expected to include a review of the operational & reputational risks that banks face.
This comes after determining that a review of the loan books alone would not provide enough insight into the exposure to climate change.
Inquiring into banks’ trading practices is an additional obstacle for an industry that has already warned that it would be unprepared for next year’s climate stress test.
Politicians in Europe want banks to play a crucial role in combating climate change by diverting capital away from polluters.
The ECB is requesting more information than other central banks and has increased pressure on the industry to fulfill the deadline.
Banks with carbon-intensive balance sheets may face increased capital requirements. This could in turn reducing their ability to pay dividends.
The ECB is also asking banks for data on emissions connected with their revenue. This is an approach that the Bank of England omitted for its climate tests this year due to a lack of relevant data.
EU banks will have to estimate the carbon footprints of their interest and fee income. The banks will also have to provide data on their biggest clients that they provide loans to.
This additional disclosure is another layer of complication to the procedure. But the extra data is expected to allow the ECB to see what would happen to portfolios if they are subject to the losses of carbon-intense companies.
Both the Bank of England and the ECB are encouraging lenders to use a 30-year horizon when analyzing their balance sheets and the risks associated with a transition away from polluting industries.
The Bank of England is requiring banks to also assess physical risks such as extreme weather or wildfires over a three-decade horizon.
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