Physical Risk Not A Key Financial Risk Yet; Materiality Levels Vary in EU Banks' Climate Disclosures in Pillar III Reports

This is the third in a series of commentaries discussing quantitative data of environmental, social, and governance (ESG) disclosures in European banks' (the banks) Basel 3 Pillar III reports. The analysis is based on a sample of 16 large European banking groups across nine countries and, in this commentary, we discuss Physical Risk.

Key highlights:
-- We currently find it is problematic to assess or compare physical risk based on banks' reporting. Our high-level analysis mainly highlights the many limitations of physical risk data and the difficulty to compare between banks.

-- We nonetheless find some sectors already clearly need further monitoring absent mitigants such as Agriculture, Forestry and Fishing, Electricity, Gas, Steam, Air Conditioning Supply, and Mining and Quarrying, as well as Real Estate and Construction, particularly if these sectors represent an important share of the bank's nonfinancial corporates book.

-- Going forward, we expect the European Banking Authority and the banks will build on the experience of these first rounds of disclosures to improve consistency and transparency in the reporting of physical risk data.

-- Granular data on regional exposure would be helpful for investors to form their own views using climate data, particularly for the residential and commercial property books.

"The banks do not report physical climate risk as a key financial risk yet", said Vitaline Yeterian, Senior Vice President at Morningstar DBRS. "This is probably because of mitigants in place (such as insurance). We also note some banks do see a significant share of their portfolios as sensitive to acute and/or chronic physical climate risk absent mitigants; however, the majority does not."