EBA’s new guidelines offer a beacon of hope amid regulatory uncertainty

While several North American banks exit the voluntary NZBA (Net Zero Banking Alliance), European banks must bolster their climate risk frameworks. The European Banking Authority’s (EBA) recently published guidelines on ESG risk management offer a beacon of hope amidst the turmoil that currently surrounds the EU’s sustainable finance regulations. These guidelines are encouraging in both substance and form, reflecting prudential supervisors’ commitment to aligning the banking sector with the bloc’s climate and sustainability goals.

The most notable takeaway is the requirement to ‘develop a single, comprehensive strategic planning process’ that meets all regulatory and business needs to prepare for the transition. Banks should leverage this holistic approach to ensure consistent transition plans whether for prudential or regulatory purposes (such as CSRD and CSDDD). The need for consistency – a point already reiterated by I4CE - also fuels the debate on the upcoming omnibus ‘simplification’ regulation through which the European Commission (EC) aims to reduce firms’ sustainability reporting requirements by 25%.

Through a comprehensive, integrated approach, the EBA makes a big step forward encouraging banks to fundamentally adjust their business models, strategies and internal processes in response to increasing climate and transition risks.

Nonetheless, the guidelines allow for ‘less sophisticated processes’ for non-large banks while emphasising robust materiality assessments. The underlying proportionality principle reflecting that ‘size is not the decisive factor’ for simplification requires that banks also consider the nature and complexity of business activities. Such flexibility might inadvertently encourage non-large banks, should they find themselves no longer subject to CSRD transition plan requirements, to regress to insufficient, weaker risk assessments. The absence of minimum thresholds in the guidelines could potentially compromise the ambition and robustness of materiality assessments, diluting the impact of transition planning exercises.

Another significant aspect of the guidelines is the assessment of the vulnerability of clients to climate and transition risks, with the EBA advocating for engagement as an effective risk mitigation tool. The final guidelines include important counterparty-level outcomes to mitigate risk through mechanisms including adjustments to product offerings and support with clients’ transition efforts. Importantly, engagement is seen as both a data-sourcing process and a risk mitigation tool.

Banks should not only rely on publicly reported CSRD transition plans, but proactively engage with firms to source sufficiently granular data concerning their preparedness for the transition.

This is a crucial inclusion in the EBA guidelines that lays the groundwork for orienting banks’ financial flows towards real economy transition needs. Despite the risk-based view of the CRD-based transition plans, the EBA argues that risk management should be sufficiently forward-looking, supported by credible scenario analysis to measure (mis) alignment with national and European climate objectives. For instance, a client’s dependency on fossil fuels is a useful indicator of vulnerability to transition risks. Nonetheless, a more proactive approach will need further regulatory incentives in directing banking flows to finance transitioning activities, especially for high-risk or ‘brown’ assets (see I4CE paper).

It is essential to note that CRD-based transition plans or plans mandated under the new ‘banking package’ (Capital Requirements Directive 6) are not a disclosure requirement. These plans represent the risk-based, but forward-looking overview of a bank’s resilience to ESG risks and preparedness for the low-carbon transition. Relevant national prudential authorities will assess the plans under the Pillar 2 Supervisory Review and Evaluation Process (SREP). However, it is unclear whether banks could face supervisory actions or penalties under the assessment. This remains a key area to monitor.

The run-up to the publication of the first omnibus end of February will be wrought with intense debates to tackle simplification needs while maintaining Europe’s climate ambitions. The European Commission’s Competitive Compass promises to deliver ‘far-reaching simplification’ in sustainability reporting obligations for smaller firms, including SMEs.

Will the EU manage to both simplify the reporting requirements and strengthen granular data integrity to support its ambitious transition trajectory?

If too many firms are excluded from mandatory reporting requirements, it could potentially undermine banks’ CRD-based transition planning processes as they would be forced to source a larger amount of transition-relevant data from their clients. But if the omnibus dilutes the sustainability objectives of the 3 targeted texts (CSRD, CSDDD, Taxonomy), then the CRD will stand alone with the unfortunate possibility of being used as a narrow prudential risk management tool.

For now, the good news is that large banks starting in 2026 will need to fully integrate ESG risks across their traditional risk management frameworks, develop holistic transition planning processes, and prepare CRD-based transition plans for prudential supervisors. It’s time for European banks to step up their game in preparing for the low-carbon transition.