The European Central Bank (ECB) has highlighted the serious transition risks that banks face if they do not prepare for a low-carbon economy.
In a blog post discussing a report on the “Risks from misalignment of banks’ financing with the EU climate objectives,” ECB board member Frank Elderson emphasizes the importance of banks identifying, measuring, and managing transition risks in the same way they manage other significant risks.
“Eight years ago in Paris, global leaders reached a landmark agreement to limit the global temperature increase to below two degrees Celsius. Alarmingly, current scientific evidence suggests we are on a path toward a 3°C increase,” Elderson notes. “From the perspective of a banking supervisor, this is deeply concerning—the longer we delay transforming our economy, the more disruptive the transition will be, resulting in greater risks that could impact banks’ balance sheets.”
A recent ECB analysis of 95 banks, representing 75% of euro area loans, reveals that many banks have credit portfolios that are substantially misaligned with the goals of the Paris Agreement, exposing roughly 90% of them to heightened transition risks. These risks are primarily associated with investments in energy sector companies that are slow to phase out high-carbon production and lagging in renewable energy deployment.
Furthermore, 70% of these banks might face significant legal risks as they have publicly committed to the Paris Agreement, yet their credit portfolios still show measurable misalignment with it. Elderson asserts, “It is essential for these banks to work closely with their counterparties to ensure that the companies they finance are aligned with their net-zero commitments.” This issue is increasingly pressing given the surge in climate-related litigation, with approximately 560 new cases filed globally since 2021, affecting both corporates and banks.
Currently, many banks are considerably exposed to transition risks, deriving over 60% of their interest income from clients in carbon-intensive sectors. Elderson warns, “Transition planning must become a fundamental aspect of standard risk management, as it is only a matter of time before transition plans are mandated.”