From 2024, EU banks must disclose a Green Asset Ratio (GAR), showing the share of EU Taxonomy-aligned assets in selected financial assets, in their Pillar 3 reports. The GAR's primary goal is to enhance the understanding of banks' contribution to the EU's environmental and climate objectives. However, due to methodological limitations and the GAR's complexity, it is challenging to form a clear view without qualitative information.
What's Happening
The European Banking Authority's (EBA's) GAR takes effect this year. This ratio shows the proportion of banks' on-balance-sheet financing of activities (via loans, debt, and equity investments) that are environmentally sustainable according to the EU Taxonomy (see chart). The GAR's numerator and denominator exclude exposures to sovereigns, central banks, supranational entities, and banks' trading books. Importantly, EU regulation has not set a minimum GAR requirement.
Why It Matters
Although the GAR increases transparency, its design brings limitations. The GAR is a positive step toward greater transparency, may encourage growth of sustainable bank financing, and could enhance banks' standing among certain stakeholders. Yet, it provides only a limited view of banks' efforts to finance the transition and how these compare with other banks.
The GAR's denominator includes nonfinancial corporations based outside the EU, and those based in the EU but not subject to the NFRD (Non-Financial Reporting Directive), while the numerator does not. This means the maximum GAR a bank can achieve depends on exposures subject to the NFRD (see chart "maximum structural GAR"). For instance, banks with high exposures to small and midsize enterprises (SMEs) will likely produce a lower GAR because the NFRD applies only to companies with more than 500 employees and at least €20 million of assets or €40 million in revenue. Therefore, financing to counterparties not subject to the NFRD is excluded from the GAR's numerator even if they support low-carbon projects. Public disclosure also allows the calculation of the share of EU Taxonomy-aligned assets in total assets subject to the NFRD (see chart "Adjusted GAR").
The average GAR of European global systemically important banks (GSIBs) is a low 2.8% as of Dec. 31, 2023. So far this year, only EU GSIBs and a few other EU banks have published Pillar 3 reports. We expect the average GAR to increase over time since the scope of the EU taxonomy will likely increase.
What Comes Next
Legislative and regulatory initiatives may enhance banks' GAR in the medium term. Under the Corporate Sustainability Reporting Directive (CSRD), which supersedes the NFRD, all in-scope companies must report according to the European Sustainability Reporting Standards, based on a dual materiality framework defined in the legislation. The CSRD will apply to a wider range of companies than the NFRD. The European Commission estimates that companies in scope will increase to roughly 50,000 from about 11,600. Listed SMEs not subject to the NFRD will need to meet CSRD disclosure requirements, but only from 2026.
The coming Banking Book Taxonomy Alignment Ratio (BTAR) will overcome some of the GAR's limitations, since its numerator will include both EU- and non-EU non-NFRD exposures. However, the BTAR is voluntary and applies only from June 2024.
The Basel Committee's proposed requirements on disclosing climate-related financial risks could also complement the GAR. These include banks' disclosure of forecasts and data on how climate risks could affect credit quality and liquidity, in addition to exposure to sectors vulnerable to transition risks, physical risks, and financed emissions (already disclosed in EU banks' Pillar 3 reports). A final draft is expected by end-2024.
The EBA's proposed "Guidelines on the management of ESG risks" include requirements for processes, ESG risk management, and disclosure of risk-mitigation plans. The proposal includes new indicators, such as portfolio alignment metrics showing to what extent sector exposures align with achieving the applicable climate, legal, and regulatory objectives, and the share of income from sectors considered high contributors to climate change. If adopted, this information will help improve disclosure of banks' climate exposure and risk-mitigation plans.
Background In Brief: The EBA's Binding Standards On ESG Risks In Pillar 3 Disclosures
These standards, published in January 2022, include a requirement for EU banks to disclose qualitative and quantitative information on climate-related risks. This includes, for example, exposures to sectors considered high contributors to climate change, energy performance certificates for real estate collateral, exposure to the top 20 carbon-intensive firms, loans subject to physical risks split by sector and geography, the GAR, and the BTAR.
Although the disclosure uses a standard format, we believe some data are not fully comparable, since the underlying methodologies and assumptions can vary among banks. For instance, the template for exposures to physical risks shows significant discrepancies between banks with similar business models and geographies, instead of relatively similar exposure to physical risks.
Related Research
- EU Banking Package: Inconsistencies Temper Framework Improvements, Jan. 9, 2024
- ESG Research: Bank Regulation And Disclosure To Foster Climate-Related Risk Analysis, Oct. 3, 2022
- Credit FAQ: The EU Green Taxonomy: What’s In A Name?, Sept. 11, 2019
This report does not constitute a rating action.
| Primary Credit Analyst: | Francesca Sacchi, Milan + 390272111272; francesca.sacchi@spglobal.com |
| Secondary Contacts: | Emmanuel F Volland, Paris + 33 14 420 6696; emmanuel.volland@spglobal.com |
| Nicolas Charnay, Frankfurt +49 69 3399 9218; nicolas.charnay@spglobal.com | |
| Additional Contact: | Financial Institutions EMEA; Financial_Institutions_EMEA_Mailbox@spglobal.com |
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