"Among the 95 significant institutions within the scope of this analysis, a striking 90% are found to be misaligned, increasing their transition risk."

In January 2024, the European Central Bank (ECB) published a report “Risk from misalignment of banks’ financing with EU climate objectives” (Report) which examines transition risks and the effect of such risks on the credit portfolios of financial institutions.

Higher carbon prices, dependency on energy prices, asset stranding, environmental regulations and changing consumer preferences mean corporates in energy intensive or CO2-intensive sectors (particularly those who have not taken steps for decarbonising) could experience reduced competitiveness resulting in an increased increase risk of defaults. In the event of a delayed transition, government intervention may require rapid compliance resulting in a higher risk of default.

Assessing this risk is critical for financial institutions. Financial institutions and central banks are increasingly scrutinising ‘alignment assessments’ i.e. the difference between a corporation’s production projection and targets set under a decarbonisation pathway. Misalignment indicates that a corporate is transitioning slower than is required under the decarbonisation pathway.

The ECB invites banks to apply the assessments, approaches and methodologies used in the Report to further develop their own alignment assessment capabilities and meet disclosure requirements under the European Banking Authority’s Implementing Technical Standards on Pillar 3.