Bank valuations at stake as EU splits with Wall Street over ESG

A man walks on a street with the European Central Bank (ECB) in the background in Frankfurt am Main, western Germany, on April 4, 2024. (Photo by Kirill KUDRYAVTSEV / AFP)

Frankfurt: The European Banking Federation (EBF) says lenders in the region won’t be able to compete with their US rivals if regulators continue to pile on environmental, social and governance (ESG) rules that Wall Street remains free to ignore.

The warning from the bloc’s main bank lobby comes as the European Central Bank (ECB) puts pressure on lenders to capture ESG risks, including in loan-loss provisions, marking a new frontier in ESG reporting standards.

The ECB is looking for evidence that banks can cope with losses stemming from what it calls “emerging risks”, which include clients’ carbon emissions and rising costs associated with consuming natural resources.

The exercise comes after a 2023 review concluded that the vast majority of banks in the region are unprepared.

It’s the latest sign that regulators in Europe are moving along a different trajectory than their counterparts in the United States.

In the European Union (EU), banks now face ESG-adjusted capital requirements, more disclosure rules and the possibility of an explicit climate buffer, all of which regulators say will ultimately equip the sector to deal with the risks ahead.

In the United States, meanwhile, planned rules and guidelines are being walked back against a backdrop of Republican-led opposition to all things ESG.

Denisa Avermaete, senior policy adviser for sustainable finance at the EBF, said ESG buffers are problematic because they’re an “exclusively European tool”.

The EBF, which is the umbrella organisation for Europe’s banking associations, is concerned that banks will be required to set aside financial reserves for risks that remain hard to quantify before getting clear regulatory instructions, Avermaete said.

So proceeding with such requirements before “the prudential framework is fully reviewed for climate risk” opens the door to “double counting”, she added.

Banks in Europe are already falling behind their US peers in investors’ perceptions. JPMorgan Chase & Co, the largest Wall Street bank, has a market value that’s 1.9 times the value of the assets on its books, according to data compiled by Bloomberg. Market pricing shows investors think Morgan Stanley is worth 1.7 times its book value.

Meanwhile, BNP Paribas SA, the EU’s biggest bank, has a price-to-book valuation of 0.7, meaning investors think it’s actually worth less than the value of its assets. Deutsche Bank AG’s price-to-book is even lower, at just 0.5.

While European bank share prices have risen over the past six months, their valuations continue to fall short of US peers, said Philip Richards, senior bank analyst at Bloomberg Intelligence in London. And “catch-up seems unlikely without a sustainable pickup in profitability in Europe”, he said.

The extent to which that will happen hinges in part on “regulatory risks”, Richards said.

The ECB says its efforts are about ensuring that banks are prepared for new risks.

Speaking at a conference in February, the ECB’s top bank oversight official, Claudia Buch, referred to climate change as an area characterised by “novel risks” that require more discussion around how banks should adjust, including the kinds of “information systems” they need in order to cope.

“And these are actually areas where we do indeed find deficiencies, not only with regard to climate,” she said.

Some banks in Europe are already starting to report environmental and social loan-loss provisions.

Rabobank, which is based in the Netherlands, said in March that it became a pioneer in the industry when it booked €13.6mil in ESG provisions for 2023.

The bank said in an email to Bloomberg that the money is supposed to cover potential chronic climate events such as future floods and droughts.

The initial provision is small, but Rabobank said the move marks an “important” step to “incorporate the impact of these potential events in the provisions”.

The ECB has grown increasingly active in its efforts to get lenders to treat ESG risks – particularly climate change – as financially material. The Frankfurt-based central bank has conducted climate stress tests and even threatened some lenders with fines for failing to take ESG risks seriously.

A 2023 study by the ECB found that almost three-quarters of European banks’ corporate loan books are exposed to nature-related risks. And ECB executive board member Frank Elderson said earlier this year that he and his colleagues “will continue insisting that banks actively manage the risks” associated with dealing with climate change.

Elderson’s comments accompanied a report in which the ECB said that about 90% of eurozone banks it studied are “misaligned” with the international goal of limiting global warming to 1.5 degrees Celsius, a proportion the ECB itself called “staggering”. The report has irritated many in the finance industry who think the ECB is overstepping its mandate, Bloomberg has previously reported.

EU regulations are designed to impact all firms with clients in the bloc, which means that the European operations of US banks are affected. But at the group level, EU banks are far more exposed to the full brunt of tighter EU regulations than their US peers. — Bloomberg

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