Is the EU Banking Sector Ready for Fit-for-55? Insights from the Recent EBA Climate Risk Reporting Template

by Hector Chavez & Melvin Jayawardana

The Fit-for-55 initiative is an all-inclusive project, spanning various legislations to address sectors substantially impacting greenhouse gas emissions. On November 17th, 2023, the European Bank Authority (EBA) released the initial template, which is mandatory for 110 European banks[1]. It is crucial for financial organisations, particularly banks, to stay well-prepared for impending changes and to adhere to essential guidelines.

The EBA’s primary objective is to gather insights into the financial system’s capacity to facilitate the transition to a lower carbon economy under current conditions. This includes assessing alignment with the proposed 2030 target. The information submitted by the initial 110 banks, including twelve Italian banks, five Irish banks, and three Luxembourg banks. The sample will serve as a pilot test, guiding other banks and entities in the financial sector. This involves contributing climate-related and financial data on credit risk, market dynamics, and real estate risks.

Information disclosure as the main pillar

The quantity and quality of information are crucial for achieving rational and appropriate decisions, nevertheless, transparency and reliability are crucial components. As the Basel Committee suggests accuracy, consistency, and quality of climate-related data are still evolving, but disclosure of such information will facilitate correct risk assessments by banks[2]. Accurate information from banks will aid in managing reforms and successful projects to reduce net greenhouse gas emissions by at least 55% by 2030 — a pivotal milestone before achieving the EU’s climate-neutral status by 2050.

The data supplied through the EBA template will also form the basis for a climate risk stress test for European banks, expected to conclude by the first quarter of 2025. This stress test, assisted by the European Systemic Risk Board, will examine three scenarios, comparing them to a baseline where Fit-for-55 implementation progresses as planned[3]. Assessing the EU banking system’s resilience to potential climate risks is vital for understanding exposure.

Risk management frameworks and stress testing practices must incorporate climate-related and environmental risk drivers, aligning with the European Central Bank’s Good Practices for Climate-related and Environmental Risk Management Review published in 2022. Providing information on banks’ current environmental impact is not enough, addressing risks comprehensively — from risk appetite to policies and procedures to bank reporting — is imperative.

These guidelines and changes necessitate further engagement, insight, and increased investment. While impactful on banks, they are crucial for long-term environmental sustainability. The financial sector, as the engine and guarantor of products, projects, and companies, plays a significant role. Moral and social responsibility should be integral to every financial institution’s investment and business decisions.

Consequences and penalties

Entities like the European Central Bank (ECB) must apply pressure on banks to align with EBA requirements. ESG factors are reshaping the banking sector’s risk profile. The ECB and EBA warn of financial punishment for banks failing to manage climate and environmental risks. The challenge lies in the weight and veracity of these penalties, which must be sufficient to alarm banks, preventing scenarios where revenues from unsustainable investments equal or exceed the penalties.

Facing tough penalties is a reality since banks are under scrutiny for not meeting the ECB’s 2020 climate risk expectations. Frank Elderson, an ECB executive board member, in a recent speech, expressed disappointment, leading to enforcement actions for the unsuccessful bank’s performance to meet the Paris Agreement target. This aligns with the growing focus on climate standards, as highlighted in the Fit-for-55 initiative. Banks need to brace for stricter measures, emphasising the urgency to align with climate goals or face consequences.

Authority participation in the banking sector

National supervisors, such as the Commissione Nazionale per le Società e la Borsa (CONSOB), Irish Financial Services Regulatory Authority (IFSRA) and Commission de Surveillance du Secteur Financier (CSSF), in Italy, Ireland and Luxembourg, respectively, will play a delegated role in ensuring prompt and complete reporting by all parties involved. Central banks, burdened with global financial stability, face increasing pressure regarding climate change within their countries. This issue unites everyone, marking Europe’s most ambitious project.

According to the ECB, banks are slow to address climate and environmental risks, impacting their bottom line. Early initiatives are crucial to avoid unfavourable market positions. Being prepared, informed, and committed to a lower appetite for climate and sustainable risk is essential to fit into this transformational change set by the European Commission.

In summary

Navigating this complexity is challenging, unclear legislation and a lack of data create uncertainty. At Parva Consulting, we acknowledge the seriousness of projects involving climate and sustainability risks. We stay informed about the latest developments, tools, and information to help achieve ambitious results within the coming years, helping the financial sector to become more sustainable.

In conclusion, implementing the ‘Fit-for-55’ legislation throughout Member States is a crucial step forward in our common journey toward a greener future. As the National Energy and Climate Plans (NECPs) near completion, their integration with this new legislation becomes critical, laying out the road map for meeting the ambitious 2030 climate and energy targets nationally.

[1] Official sample available on FF55 – Sample.xlsx (europa.eu)

[2] https://www.bis.org/press/p231129.htm

[3] Request for a one-off scenario analysis exercise to be conducted jointly by the European Supervisory Authorities, the ECB, and the European Systematic Risk Board in accordance with the Communication from the Commission of 6 July 2021 “Strategy for Financing the Transition to a Sustainable Economy”