KPMG Market Survey on Climate & Environmental Risks in Credit Risk Models

Following the publication of the ECB guide on climate-related and environmental risks (CER) in Europe in 2020, supervisory attention and requirements on climate and environmental risks are further expanding, with the revised ECB guide to internal models (2024), CRR III and CRD VI amendments, and the gradual extension of CSRD application. This high attention is expected to continue especially in light of the observed and forecasted economic losses due to environmental hazards: significant economic losses are experienced due to severe flooding and storms in Germany, Italy, France, Spain, and Central & Eastern Europe in 2024 alone.

With this in mind, we conducted a survey to analyse where banks stand in their journey towards CER integration in risk classification and credit risk models. The study focused on the integration for Large Corporates, Residential Real Estate (RRE) and Commercial Real Estate (CRE) portfolios.

Many banks have made considerable progress and are now adopting improved approaches compared to a few years ago. For example, the survey results show that 50 percent of significant institutions (SIs) already meet supervisory expectation 8.2 regarding the adjustment of risk classification procedures in credit risk management for Large Corporate portfolios  - another 30 percent plan to catch up by the end of 2025.

Further trends are identified from the self-assessment by survey participants. For example, the study examines changes in organizational structures and approaches to reflecting CER in risk classification, rating assignments, IFRS 9 provisions, and the economic capital. It also explores the current or planned use of client- or asset-level data for these purposes.

To successfully integrate climate and environmental risks into credit risk models, banks need to take a strategic and proactive approach. This requires the following steps:

• Identify compliance gaps in relation to supervisory expectations across internal ratings, economic capital and IFRS 9 loan loss provisioning frameworks.
• Facilitate modelling and rating teams with the necessary regulatory and technical expertise to assess climate and environmental risks.
• Update policies and procedures for rating assignment, as well as for model development, monitoring, and validation.
• Establish a consistent, integrated data landscape to efficiently handle CER data across credit risk models.
• Develop a clear action plan, supported by senior management, to meet regulatory expectations, address deficiencies, and ensure consistent CER integration across all risk models, with cross-departmental coordination to maintain transparency and accountability.

ECB-supervised Significant Institutions (SIs), selected SI-equivalents and rating solution providers in Europe as well as other selected countries participated. There were 47 participants in total, including 30 SIs. The responses and self-assessments were mainly provided by the functions responsible for the practical modelling of credit risk in the institutions.

The observed trends, underlying observations as well as implications and outlook for institutions are discussed in greater detail in the white paper "Climate and Environmental Risks in Credit Risk Models", which you can download now.