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For a recent study, the ECB conducted a quantitative analysis of transition risks in the credit portfolios of 95 banks, encompassing 75% of euro area loans. The assessment employed an 'alignment assessment' methodology, gauging the disparity between production projections and decarbonization pathway targets of companies within the banks' portfolios. The study focused on companies operating in six pivotal and carbon-intensive sectors, namely Power, Automotive, Oil & Gas, Steel, Coal, and Cement. These sectors collectively contribute to 70% of global CO2 emissions, highlighting their significance in the analysis.
The study revealed that out of the 95 banks examined, only 8 demonstrated lending practices aligned with a 2050 net-zero pathway. In contrast, a significant 90% were identified as misaligned, thereby elevating their transition risk. Key contributing factors to this heightened risk included the financing of companies that were slow to phase out high-carbon production capacities and a delay in the expansion of renewable energy production.
Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, highlighted the specific vulnerability of these banks to litigation risk, especially in light of the significant surge in climate-related lawsuits. Elderson stated:
“This is more relevant than ever, considering that climate litigation has skyrocketed in recent years. Globally, some 560 new cases have been filed since 2021 and increasingly also targeted at corporates and banks.”
While credit risks were relatively less pronounced, as evidenced by 60 banks having misalignment exposures below €1 billion, a notable subset (14%) faced larger exposures exceeding €5 billion, with six banks surpassing the €10 billion mark. The study also highlighted the potential for a rapid escalation in misalignment, indicating that exposure could increase by over 50% if credit lines to these companies were fully utilized. Furthermore, the study revealed that some of the most misaligned banks, in comparison to their Common Equity Tier 1 (CET1) capital, exhibited a relatively high exposure, suggesting a potential impact on solvency at these banks due to climate transition risks.
The report identified a significant source of transition risk for banks, revealing a tendency to provide larger loans to misaligned companies, thereby exposing themselves to substantial risk. The average exposure size to misaligned companies was found to be more than double that of aligned companies.
The degree of misalignment varied across sectors, with banks displaying higher misalignment to sectors with earlier transition pathways. In contrast, smaller misalignments were observed in sectors lacking viable zero-emission alternatives, such as steel and cement, which have more extended timelines for decarbonization according to the International Energy Agency's (IEA) 2050 net-zero emission (NZE) scenario. Notably, financing portfolios for the automotive sector exhibited a notably higher degree of misalignment, as many companies funded by the banks lagged in transitioning to electric vehicle production, despite the scenario envisioning the phase-out of fossil fuel cars by 2050. Overall, almost all banks demonstrated misalignment across all sectors, except for steel.
The report delved into the influence of technologies on the alignment of banks' portfolios with the climate transition. It revealed that a considerable proportion of misalignment in banks' portfolios was attributed to companies slow to phase out their production of carbon-intensive technologies. This included entities lagging in the phase-out of coal, oil and gas mining and extraction, as well as automotive companies falling behind in transitioning away from internal combustion engines. Moreover, more than 30% of the identified misalignment was traced back to a deficiency in financing for renewable energy sources, particularly evident in the power sector.
Click here to access the report: