ECB Embeds Climate and Nature Risks at the Core of Monetary Policy

The European Central Bank (ECB) has finalized its plan on climate and nature: integrating environmental risks into monetary policy decisions, banking supervision, and portfolio management. The focus now shifts to the green transition, physical risks, and ecosystem degradation.

Climate and nature are firmly embedded in the Eurosystem’s monetary policy, banking supervision, and balance sheet management: no longer “ancillary” issues, they are now factors that influence inflation, bank stability, and economic growth. This is the message sent by the European Central Bank (ECB) in announcing the conclusion of its 2024-2025 Climate and Nature Plan, whose implementation has allowed the institution to take a decisive step in integrating climate and environmental risks into its core activities.

Over the past two years, the ECB has worked to translate its mandate into concrete actions, strengthening its ability to assess and manage risks that increasingly directly impact price stability, the functioning of the financial system, and the soundness of European banks. With the full implementation of the plan, climate change and ecosystem degradation are no longer considered external or long-term shocks, but structural factors capable of impacting Europe’s economic, financial, and social growth and stability.

In which areas has the ECB acted?

One of the cornerstones of the ECB’s action has been the strengthening of the integration of climate and environmental factors into the monetary policy framework. Climate-related considerations have been further incorporated into the Eurosystem’s operational framework, including the collateral framework, while the reduction of the carbon footprint of central banks’ corporate bond portfolios has continued. At the same time, transition policies, such as the introduction of the Emissions Trading System 2, have become fully integrated into macroeconomic assessments and official projections, marking a step change in the way monetary policy analyses the economic environment.

A second key area concerns improving data and risk analysis capabilities. The ECB has conducted and supported climate stress testing exercises and scenario analyses, including Fit for 55, and has taken a leadership role in developing climate scenarios within the Network for Greening the Financial System. Statistical climate indicators have been updated with new methodologies and databases, strengthening the monitoring of sustainable finance, decarbonization efforts, and the impact of climate-related physical risks, such as extreme events and water stress.

On the supervisory front, “the ECB’s work has contributed to improving the banking sector’s ability to identify and manage climate-related and natural risks,” a statement reads. “Euro area banks are now more aware of their exposures, thanks in part to ongoing supervision that, where necessary, has included the adoption of binding decisions.” The goal is to strengthen the financial system’s resilience in the face of increasingly frequent and intense shocks, preventing environmental risks from translating into systemic risks.

At the same time, internal operations have also made progress. The ECB continued to integrate climate criteria into the management of portfolios not directly linked to monetary policy and reduced emissions from its operations by 39% in 2024 compared to 2019 levels, in line with its 2030 environmental targets.

Finally , progress on the nature front is particularly significant . For the first time, the updated monetary policy strategy explicitly recognizes that ecosystem degradation can have direct implications for monetary policy. Research conducted by the ECB highlights a profound interconnection between nature and the euro area economy, identifying water-related risks, from water scarcity to floods, as one of the most critical factors for economic and financial stability.

The ECB’s three strategic priorities for the future on climate and nature

With the closing of the 2024-2025 plan, the ECB has identified three strategic priorities for the future:

accompany the transition to a low-carbon economy, through the assessment of banks’ prudential transition plans, ongoing analyses of energy and tax costs, and the exploration of how climate considerations can be further integrated into the operational framework;

Strengthen capacity to respond to the physical impacts of climate change , through strengthened macroeconomic analysis, improved data and risk monitoring, and further insights into banks’ capacity to address physical risk challenges;

deepen the analysis of the risks associated with nature loss and ecosystem degradation , including that of the impacts of risks associated with water resources.

These guidelines will complement ongoing work on monetary policy, banking supervision, and financial stability, including the evolution of stress test models and the continuous improvement of data and disclosures.

The message is clear: for the eurozone’s central bank, climate and nature are no longer external variables to monitor, but a structural dimension of the context in which it exercises its mandate. In an economy increasingly exposed to physical and transition risks, the ability to integrate them into decisions will be key to ensuring the stability, resilience, and credibility of the European financial system.

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(Featured image by Masood Aslami via Unsplash)

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First published in ESG NEWS. A third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

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