US bank lobbyists claim ECB ignoring risks of fast transition

The method for measuring climate transition risk used by the European Central Bank (ECB) does not align with the “actual economy” and doesn’t consider the risks from transitioning too fast, a leading US bank lobby group has said.

The Bank Policy Institute (BPI), which represents some of the largest US banks, including Goldman Sachs, JP Morgan and Citibank, criticised an ECB report that found eurozone bank lending portfolios are misaligned with climate targets and face transition risks.

“The assumption that misalignment of a company with government climate goals always leads to increased transition risks is false,” the BPI paper states. “In fact, a company’s transition risk can increase if a company is transitioning in line with government goals but the underlying economy and policy environment in which the company operates are not keeping pace. Transitioning too fast may create risks for a company’s business.”

Instead, the BPI says banks should separate how they manage credit risk impacts of transition risk from their efforts to align their finance emissions with government goals, as transition risks are dependent on other factors. The lobby group gives the example of car rental company Hertz, which suffered financial losses because its move to electric vehicles did not meet demand.

The ECB considers combating climate change part of its mandate and has published many research papers tackling various methodologies for assessing potential climate change risks.

While the BPI claims the ECB thinks banks should manage their risk by not lending to companies that are not decarbonising, executive board member Frank Elderson has previously said that the push to focus on climate risk isn’t about divesting from carbon-intensive industries but “it is, instead, a call to actively manage the risks, for instance, through client engagement and transition and resilience finance”.

“In other words, banks must be cognizant of the risks they take and manage them accordingly,” Elderson said in a speech in March.

The BPI paper refers to a separate study that found a 50% reduction in greenhouse gas emissions would lower the probability of default by about 36%, which it claims is lower than other credit risks. While it concludes that transition risk can be incorporated into credit risk management, this is only the case if a company’s business model is not affected by cutting emissions.

“Regulatory authorities should be careful not to encourage or require banks to divert risk resources from other, larger risks by overemphasising transition-related credit risk,” the paper states.

The paper also says banks should not assume that reducing financed emissions will reduce legal risks, as it depends on the stance taken by different jurisdictions. Other experts have warned that climate litigation is a growing risk that all firms should be aware of.

Anne Perrault, a senior climate finance policy counsel at advocacy group Public Citizen, told Green Central Banking that the paper misses the point of considering transition risk, which is a response to the current climate reality. Instead, the BPI is implying that the risk is the ECB’s pathway and not the current climate situation.

“It’s not the financial risk they’re used to. It’s not their father’s risk or grandfather’s financial risk, it’s a different kind of risk… That’s exactly the mindset that has put us in this situation we’re in now, which is stuck between horrifying, increasing physical harm and increasing transition risk,” she said.

The threats from climate change are growing and the government support and subsidies, which hid the extent of the damage for many years, are running dry. Government policy on reducing carbon emissions is insufficient which is why extreme weather events are increasing, she said.

Meanwhile, the fact that companies did not transition to a green economy when they could have more comfortably is exactly why there are growing pains now, Perrault added. While there is no comfortable way out, waiting will only make it worse.

“This case study seems to say the status quo is better for banks than the transition. Even assuming that’s true, the status quo isn’t an option,” she said.