ECB has banks bracing for capital hit as climate risk tested

Frankfurt

EUROPEAN banks are concerned that their top regulator will use its upcoming climate stress test to raise the bar for capital.

The mass of data banks must soon submit to the European Central Bank (ECB) could be used to justify higher capital requirements as soon as next year, according to lobbyists representing the industry. Efforts to get clarity from the ECB have been met with a degree of evasiveness, which adds to the level of anxiety, the people said.

In its public statements, the ECB has said that the tests are a chance for the banks and the regulator to learn about how vulnerable they are to extreme weather and to tougher climate-related laws. Individual test results won't be made public, and the ECB has sought to reassure the industry that it will take a nuanced approach to drawing any conclusions for capital. But it has also made clear that climate change will ultimately be treated like any other risk.

"I don't think the regulator would waste time on this if at some point it wasn't going to evolve into a methodology for calibrating capital for banks and their distributions," said Joseph Dickerson, an analyst at Jefferies Financial Group Inc. An ECB spokeswoman declined to comment. The exercise starts in March with aggregate results due in July.

Banks have railed against the idea of the ECB using the test to roll out new rules to address climate risk, with Deutsche Bank chief executive officer Christian Sewing calling last month for the watchdog to show "clear-sighted leadership" on the topic.

Banks often campaign against higher capital requirements as they can reduce funds available for bonuses and investor dividends.

"I hope and think that such a stress test won't be used to change capital rules in any way," Sewing told reporters.

The ECB says the results will feed from "a qualitative point of view" into this year's review of the risks that individual banks face. That means they could indirectly affect the capital requirements that regulators set for each bank individually on an annual basis.

That leaves room for the regulator to raise the bar for next year, according to the bank lobbyists Bloomberg News spoke with. They're also worried that the ECB will use the climate test results to justify a stricter approach when setting capital requirements for 2024, they said.

Comments from senior ECB officials appear to validate the banks' longer-term concerns. The test "isn't the end of the story", Edouard Fernandez Bollo, a member of the ECB's supervisory board, said in an interview with Revue Banque published this month. "Eventually we will have capital requirements. For example, if we have figures that are reliable and that demonstrate that banks need to set this capital aside."

One of the lobbyists said there's concern that some regulators want to go beyond looking at how banks deal with the risks they face and use capital as a blunt instrument to try to steer them away from lending to companies that pollute. The ECB said last month the stress test is intended to assess how prepared banks are for dealing with financial and economic shocks stemming from climate risk.

Some members of the regulatory establishment reject the idea that they're trying to steer the business banks conduct. Mark Branson, head of German financial regulator BaFin who also sits on the ECB's supervisory board, said on Tuesday (Feb 8) that he has "a very clear view that our mandate starts and stops with financial risk."

He went on to say that he also has "a very clear view that there are financial risks that are connected with climate change which could be over time be very material and we have enough to do to look at that and to persuade the financial industry to be looking hard at that".

The ECB isn't alone in its efforts to address climate risk among banks. While the United States has taken less action so far than its Frankfurt-based peer, the Federal Reserve said last year that it's committed to working within its mandate to address the implications of climate change.

Global financial institutions representing some 40 per cent of worldwide assets have pledged to reduce the greenhouse gas emissions that their lending causes to zero on a net basis by 2050.

Banks in Europe are most at risk of facing higher capital charges if they manage data badly and have weak governance, if the test shows they're more vulnerable than peers or if they don't address shortcomings, said Monsur Hussain, an analyst at Fitch Ratings. Such charges are more likely to take effect in 2023 than this year, he added.

The ECB has already faulted banks for being too slow in preparing for the risks that climate change poses, saying in November that no lender is close to meeting all its expectations in this area.

Lobbyists including the European Banking Federation argue that, for now, climate concerns are better off dealt with inside the regular capital discussions with the supervisor instead of in a bespoke stress test. Those discussions are usually strictly private. And while bankers complain that they don't have enough data to fully assess climate threats, some argue that they already take account of them.

"It is an overarching type of risk that is already included in our capital cost," Ljiljana Cortan, chief risk officer at Dutch lender ING Groep, said last week. Climate will play a bigger role in future, but further regulation needs to be put in place if the ECB wants to take a harder tack on the industry, she noted. BLOOMBERG