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Climate-related and environmental (C&E) risks are becoming an inevitable part of banks’ business strategies and risk management frameworks. To operationalise C&E targets and the related risk appetite, financial institutions are mobilising resources to integrate C&E-related key performance indicators (KPIs) and key risk indicators (KRIs) into their processes. EU policymakers are taking further steps to help the financial sector address capability gaps.

Banks play a pivotal role in the transition of the EU economy to climate neutrality by 2050 in line with the European Climate Law (with a significant reduction by 2030 in line with Fit-for-55) as they can direct markets toward the targets by curbing financing or revising financial instrument pricing. Major banks have announced their own commitments to sustainability, including climate-related, increasing the importance of implementing C&E-related strategies and relevant KRIs and KPIs. In the EU, the establishment of C&E KRIs and KPIs is mainly regulated by the ECB Guide on climate-related and environmental risks (Expectations 2 and 4 due to be implemented by banks by December 2023). Further guidance is given in the EBA Report on management and supervision of ESG risks for credit institutions and investment firms, and the requirements of national central banks and regulators in EU countries. Banking supervisors may take supervisory measures to direct banks towards compliance, such as the Pillar 2 capital increase for a small number of institutions at the outcome of the ECB 2022 supervisory exercise on C&E risks.

Figure 1. C&E-related transformation by banks

Graphic Risk Management Banks

Source: KPMG in Germany, 2023

Notes: The graphic outlines how the transition to a sustainable economy drives banks’ transformation. Specifically, banks need to amend their business and risk strategies by setting C&E-specific KPIs and KRIs and reflecting these through C&E-informed business decisions (including credit lending).

As observed by our KPMG experts, banks face various challenges in operationalising their C&E commitments. One of the main challenges relates to C&E data. On the one hand, certain C&E data is already available to banks yet spread across the institution. Disclosure requirements directed towards banks, such as the EBA’s ESG Pillar 3 requirements, will help banks to mobilise their efforts to enhance C&E data integration. On the other hand, client-level C&E data may not be available to a bank if the client does not disclose such information. In this case, banks may consider the use of proxied C&E data until disclosure requirements, such as corporate C&E disclosure (CSRD), improve their access to granular client-level data.

Best market practice includes four key steps for operationalising C&E commitments: 1. defining the risk strategy for C&E risks, 2. defining C&E-related KRIs, 3. limit setting and integrating C&E KRIs in the risk appetite framework, and 4. monitoring, reporting and escalating the implementation of C&E KPIs and KRIs. KPMG’s project experience and ECB observations on good practices show that mature banks are introducing various C&E KRIs and KPIs. For instance, a KRI may represent the threshold for misalignment with a climate-related transition trajectory, while a KPI may reflect the amount of financed emission reduction targets at the portfolio level.

With the integration of C&E KPIs and KRIs into their business strategies and risk management, banks can better navigate towards their C&E targets and strengthen their decision-making processes, particularly in credit lending. Banks that proactively set C&E targets in close collaboration with risk management gain more tangible insights for managing C&E risks and are better able to assess and manage the potential impact of climate and environmental events on their operations.

In the white paper The need to act: Climate & environmental indicators in banks’ strategies, we discuss what challenges banks face when implementing C&E KRIs and KPIs, address how to approach those challenges, and outline the benefits of action.