ECB Updates Climate and Nature Risk Compendium Drawn from Practices at 60+ European Banks

The European Central Bank has updated its compendium of good practices for climate and nature-related risk management and stress testing, drawing on approaches already applied by more than 60 directly supervised institutions. The updated framework targets gaps across physical risks, prudential transition planning, scenario analysis and nature-related risks, and is designed to be useful for both larger banks and smaller, less exposed institutions. The publication marks one of the most detailed supervisory references on climate and nature risk management issued in Europe to date.

 

Why the Compendium Has Been Updated

 

ECB Banking Supervision has observed measurable improvement in how euro area banks manage climate and nature-related risks, with all directly supervised institutions now having foundational architecture in place to identify, quantify and manage these risks. Despite this progress, the ECB warns that more work is needed to ensure sound practices are applied across all material portfolios, exposures and risk categories. Methods used for measuring physical and nature-related risks remain in their infancy and are very likely to underestimate the underlying exposure.

The updated compendium responds to repeated requests from banks during supervisory dialogue for clearer insights on managing climate and nature-related risks. It is intended to serve multiple functions within banks, providing examples in sufficient detail to be operationally useful while focusing on areas where industry practice is typically less developed. The ECB emphasises that good practices have no legally binding effect and do not establish new regulatory requirements, but rather provide a range of examples that banks may draw on when building robust risk management capabilities.

 

The Risk Landscape Driving the Update

 

The evolving risk landscape has made climate and nature risk management increasingly challenging, with the European supervisor warning that the region is heading toward a disorderly transition scenario with elevated uncertainty. Frank Elderson, Member of the ECB Executive Board and Vice-Chair of the Supervisory Board, said it is crucial for banks to be resilient and prepared for a range of possible scenarios, including higher and faster-moving transition and physical risks. The framing reflects growing supervisory concern that climate-related shocks could materialise more abruptly than current risk models assume.

The forward-looking and non-linear nature of these risks remains poorly understood across the financial system, which increases the likelihood that they are underestimated. The growing insurance protection gap and strain on public finances are also weakening the role of governments as insurer of last resort for climate and nature-related losses. These dynamics imply that climate and nature risks could have an increasing impact on bank balance sheets over time, justifying the deeper supervisory focus.

 

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Transition Planning Under Uncertainty

 

Prudential transition planning is presented as a central tool for managing risk in an environment where future transition and physical risks cannot be predicted with precision. The regulatory framework does not prescribe a specific decarbonisation pathway but requires banks to think consciously about strategy in light of plausible scenarios, set their own long-term objectives and maintain efficient risk management frameworks. Practices remain uneven across the sector and the ECB will continue to address transition planning in supervisory dialogue in the coming months.

Some banks are using their technical knowledge of hard-to-abate sectors such as cement, steel and aviation to design transition finance strategies and products, rather than retreating from these client relationships. The approach creates a dual benefit by supporting clients on their decarbonisation pathways while diversifying bank income streams through transition advisory services. This model is increasingly seen as more risk-sensitive than blanket disengagement from carbon-intensive sectors.

 

Client Engagement and Strategic Pricing

 

Banks have begun incorporating physical risks into their prudential transition plans, with the more advanced institutions moving beyond blanket pricing approaches toward client-specific engagement strategies. Some banks now focus on the physical risk impacts on specific collateral held by individual clients, providing a more granular view of exposure than regional or sector-wide adjustments allow. This shift is increasingly seen as more risk-sensitive and effective in managing physical risk concentrations.

Some banks have also begun accepting lower margins in the short term on renewables and other transition-related lending in order to build long-term positions in growth markets. These institutions are investing in internal expertise, data infrastructure and client relationships over a longer horizon, while developing targeted transition finance products and pricing incentives. A growing number of banks are also extending into venture debt and other instruments to support clean technology start-ups directly.

 

Scenario Analysis and Stress Testing Advances

 

Scenario analysis and stress testing remain indispensable for managing climate and nature-related risk, with banks improving estimation methodologies but still facing significant work to broaden their risk management toolkits. The compendium highlights two areas of particular progress, the first being transition risk modelling at the counterparty rather than purely sectoral level. Some banks now estimate how scenario-specific developments such as higher carbon prices affect individual companies' financial ratios, then feed these indicators into internal rating systems to derive stressed probabilities of default.

The second area covers acute physical risk assessment, where leading banks are mapping exposures to the exact geographical location of individual buildings or assets rather than relying on broad regional classifications. Internal vulnerability indicators combine external hazard maps with client data, including customised drought risk indices that merge open-source hazard data with client-specific water intensity metrics. Some frameworks model the duration of business interruptions caused by floods or wildfires, allowing banks to derive stressed probabilities of default and loss-given-default metrics directly from revenue declines and collateral damage.

 

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Nature-Related Risks and Emerging Practices

 

Nature-related risks remain the area where approaches are least developed across the sector, with around two-thirds of banks not yet systematically linking their materiality assessments to specific risk management actions. Few banks have defined nature-related key risk indicators, and where such indicators exist they are often used purely for monitoring without limits or thresholds that trigger management response. Approximately one-third of the new good practices in the compendium focus on nature-related risks to help close this gap.

Some banks are now quantifying nature-related financial impacts through scenario analysis for clients operating in the most sensitive sectors and geographies, allowing them to test client resilience to risks such as water scarcity, environmental permit systems and pollution taxes. Others are integrating nature-related risks into their internal capital adequacy assessment processes, conducting nature-related scenario analyses and in some cases defining nature-related capital buffers to cover potential losses. Client engagement remains the most commonly used tool for managing nature-related exposure, supported by detailed assessment criteria and engagement policies.

 

Implications for European Banking Supervision

 

The updated compendium reinforces the ECB's position as one of the most active prudential supervisors globally on climate and nature-related risks, building on guidance issued over recent years. By documenting practices already in use across the supervised population, the framework gives banks a defensible reference for benchmarking their own approaches against peer activity. Smaller and less exposed institutions can also draw on illustrative practices at lower levels of sophistication, supporting proportionate implementation across the sector.

The framework operates alongside the European Banking Authority Guidelines on the management of Environmental, Social and Governance risks and environmental scenario analysis, which take effect in early 2027. As these mandatory guidelines come into force, banks that have already adopted leading practices will be better positioned to demonstrate compliance and avoid corrective supervisory actions. The convergence between voluntary good practices and binding regulatory requirements is expected to accelerate sector-wide implementation.

 

Outlook for Climate and Nature Risk Management

 

The ECB has signalled that climate and nature-related risk management will remain a central supervisory priority through the 2026 to 2028 cycle, with particular emphasis on risk underestimation, physical risks and risk management under heightened uncertainty. Supervisory dialogue will continue to focus on closing remaining gaps in bank frameworks and ensuring resilience to a wider range of potential scenarios. Banks that demonstrate strong execution against the compendium's good practices are likely to attract more constructive supervisory engagement than peers lagging behind.

Whether euro area banks can fully integrate climate and nature-related risks into mainstream risk management within the supervisory timeframe will depend on continued investment in data infrastructure, modelling capabilities and senior management engagement. Sustained progress is expected to position European banks as global leaders in climate and nature risk management while supporting their ability to finance the green, digital and defence transitions. The compendium provides a meaningful resource for advancing toward that outcome.

 

Source: European Central Bank