The European Banking Authority (EBA) has introduced comprehensive guidelines urging banks in the EU to measure and manage environmental, social, and governance (ESG) risks more rigorously. The move aims to address growing threats to financial stability posed by climate change, social factors, and governance challenges.
In a statement released on Thursday, the EBA highlighted the potential impact of ESG risks, particularly environmental risks, on financial institutions. “ESG risks, especially environmental risks through transition and physical risk drivers, challenge the safety and soundness of institutions and may affect all traditional categories of financial risks to which they are exposed,” the regulator said.
Under the new guidelines, banks are required to use scenario analysis to identify, prepare for, and mitigate ESG risks. These assessments should cover individual exposures, portfolio-level risks, and sectoral vulnerabilities, with a specific focus on the fossil fuel industry. Banks are also encouraged to set quantitative targets for reducing financed emissions.
The timing of the guidelines coincides with alarming data showing that global insured losses from natural disasters in 2024 were more than double the 30-year average. Recent wildfires in Los Angeles suggest the trend could continue in 2025. Additionally, banks face increasing legal risks as climate activists turn to litigation to hold financial institutions accountable for their climate impact.
The EBA’s directive also highlights the widening gap between European and US banks in addressing climate change. While major US lenders have exited the Net-Zero Banking Alliance, European banks have reaffirmed their commitment to the initiative.
European regulators are tightening requirements for banks to disclose and plan for ESG risks. The EBA’s guidelines, which have been in development for months, call for institutions to assess long-term risks by looking at least 10 years ahead and evaluate clients’ reliance on fossil fuels and their alignment with net-zero transition goals. Banks should also report potential financial risks from clients failing to meet net-zero emissions targets by 2050, allocate sufficient capital to absorb losses related to ESG risks, and prepare for potential environmental litigation.
