• Jeroen Heijneman, Senior Manager |

Since banks are devoted to ESG (Environment, Social, Governance), it’s crucial to steer a course with precision amidst rising risks posed by ESG-related factors. In light of these developments, KPMG recently conducted its third edition of the annual survey on ESG risk management at banks. This iteration revealed how banks try to keep up with rising expectations and that 2023 is to be the year in which credit decisions should systematically consider climate-related risks. 

The 13 DNB and ECB expectations on, in particular, environmental risks – the ‘E’ in ESG –  encompass a broad range of areas: from business strategy, target setting to risk measurement and reporting. You can find background information on those expectations in our earlier report on ESG risks in banks). As risk management practices are being developed, the best practices are actively shared by supervisors to provide clearer guidance on what ‘good’ looks like. Through our survey, however, we conclude that banks perceive these clarifications as a bar being set higher. Furthermore, European supervisors have become more explicit on when expectations are to be met – something which was previously left in the dark. Expectations to include climate-related and environmental risks in governance, strategy and risk management are to be met by the end of 2023. Other expectations are to be met by the end of 2024. 

In our survey, 86 European banks participated, of which 46 are directly supervised by the ECB. For many banks, intense supervisory dialogue within the past year – especially with the ECB – have led respondents to reconsider when supervisory expectations are to be largely met. Last year, 9 out of 10 banks would expect to meet expectations by 2025, whereas this year’s survey shows that only 6 to 7 out of 10 banks would still expect 2025 to be feasible. This is clearly at odds with ECB’s communicated timelines. Implementation efforts, in combination with rising expectations, seem to be more difficult than anticipated. 

Increasing investments in ESG risk management

Even in the face of these challenges, banks remain resolute in their commitment to the ESG risk management journey. Apart from the regulatory pressure, they also driven by advantages they see in better risk management and, in particular Dutch banks, are also motived by a high level of social responsibility relative to other European banks. This translates into an upward trend in budgets allocated to ESG risk management, which also a reflection of a better understanding of the significance ESG has for banks.  

Dominant challenges are around data and skilled staff

The commitment seems to be there, and realistic views of regulatory expectations are developing, so what is stopping banks from keeping up with expected timelines? Bank responses indicate two dominant challenges. Firstly, their biggest challenge is around data sourcing and management. For example, emission data on small businesses and granular data on the location of assets owned by banks’ clients is difficult to obtain. Collecting data directly from clients and sustainability disclosure standards becoming mandatory for an increasing number of companies, does provide some alleviation, but their full benefits are only expected in a few years from now. Secondly, there is a sheer lack in qualified staff. The required knowledge is very scarce and, if available within the banks, it is simply concentrated among too few persons. It started a war for talent. Banks that have been first on the labour market have an advantage. Training and study programmes receive a lot of attention in order to overcome this challenge. 

Getting organized and clarifying responsibilities is key

European banks have made significant progress in establishing permanent ESG risk tasks within line functions. Of the European banks, 60% have it in place, while it accounts for 80% in the Netherlands. Mature banks have been successful in early establishment of roles and responsibilities in all lines of defence, which does not mean their implementation efforts are as good as finished. It rather indicates that basic tasks are taken up by line functions while implementation efforts focus on enhancement and improvement of practices.

Climate-related risks remain top priority

Climate-related risks have, for both banks and policy makers, always been the top priority. We see that in order to meet supervisory expectations timely banks need  to emphasize this priority. We actually see that Dutch banks increased their priority to climate-related risks from high to very high on a 5-point scale, whereas other environmental and social risks have become less prioritized, i.e., at medium. Governance risks are even prioritized lower than medium. The high priority to climate-related risk is reflected in the risk management frameworks of mature banks, where impact assessment and quantification of climate risk is being systematically established, and were financed emissions feature almost universally among top risk and performance metrics.  

Do not underestimate greenwashing

Managing risks associated with greenwashing has not yet arrived at the top of many banks’ agendas – surprisingly, given the public focus and high-profile cases over the past years. Only 50% of the Dutch banks and 48% of the European banks participating in the survey indicate that they have processes in place to identify, prevent and manage risks associated with greenwashing. Around 70% of banks lack a clear definition of greenwashing. Banks have expressed their commitment to incorporate greenwashing risks into their frameworks in the near future. Greenwashing has, from the very start, been recognized by regulators as a side-effect of regulatory stimuli to propel towards a more sustainable economy. Regulations such as the EU Taxonomy and the EU Green Bond Standard are in fact mitigants to greenwashing. Increased awareness among staff on such regulations could already benefit banks in controlling greenwashing risks without necessarily a need to develop comprehensive own definitions. 

When the rubber hits the road

This year is marked by the high expectations that must be met. Climate-related risks need to find their way systematically into, among other things, business strategy, loan pricing and underwriting standards. It appears from our survey that banks still have some necessary and ambitious steps to undertake. We expect that supervisors will, as of next year, look at banks to see if and how they achieved this. Furthermore, disclosure standards that will come into effect, such as the Corporate Sustainability Reporting Directive (CSRD), will lead to increased transparency on banks’ maturity of ESG risk management practices. This will provide for more opportunities for comparison and for moving towards industry standards on what sound ESG risk management looks like. The year 2024 will be the year that the rubber hits the road.