ESG risks in 2025: Responding to regulatory and supervisory pressure

May 2025

What’s new and what’s next for ESG risk management? With physical and transition risks growing, both the EBA and the ECB are continuing their focus on ESG risks. Meeting these expectations will require sustained effort – but it will also build European banks’ resilience in the face of uncertainty.

2025 marks a watershed in European banks’ treatment of ESG risks. Recent political shifts in major global markets could give the impression that ESG is slipping down European banks’ agenda. In fact, the opposite is true. ESG risks continue to receive heightened attention from financial institutions as well as from EU banking regulators and supervisors.

Climate-related and environmental (C&E) risks are evolving in complex and unpredictable ways. These range from extreme weather events to the impact of biodiversity loss to companies that depend on natural resources becoming less profitable due to resource scarcity and rising costs. In 2024 alone, Germany, Italy, France, Spain, and Central & Eastern Europe were hit by intense storms, generating economic losses in the billions of euros. A slowdown in 2025 in advancing transition efforts, such as policy development and the allocation of funds to sustainable funds – could significantly increase exposure to physical risks in the years ahead.

Among transition risks asset stranding remains a key concern, particularly in commercial real estate, where EU net-zero commitments, reaffirmed at the COP29 conference, continue to underscore potential declines in collateral values, especially for older, less energy-efficient properties. Litigation risks persist, with the ECB reiterating warnings about banks' increased legal exposure related to their climate commitments. Similarly, greenwashing remains firmly on the agenda, following the EBA's report published in 2024 highlighting a notable increase in cases.

For now, EU ESG-related reporting requirements remain in force, but the 2025 Omnibus Proposal suggests simplification along with greater standardization in future, including for the CSRD and CSDDD.¹ Should future corporate sustainability reporting fail to clearly communicate ESG risks, it would make it harder for banks to assess their exposure to such risks when providing loans to corporate firms, either compromising their risk management capabilities or creating an undue burden on clients for supplementary information.²

The year began with significant momentum. On 9 January 2025 the EBA published its Final Guidelines on the management of ESG risks, which will take effect in January 2026.³ On 16 January, a four-month consultation began on draft Guidelines on ESG scenario analysis. Then in February the EBA released its report on Data availability and feasibility of common methodology for ESG exposures. These actions make it clear that the EBA will continue to prioritise ESG risks in 2025. In addition CRD 6 will introduce ESG-related requirements, taking effect from 1 January 2026. This means that banks must prepare throughout this year to ensure their internal capital planning incorporates ESG risks across short-, medium-, and long-term horizons, supported by mandatory transition plans and robust processes to identify, measure, manage, and monitor these risks accordingly.

Addressing these requirements will require European banks to enhance their tools, techniques and data frameworks. Valuable areas of focus are likely to include:

• Deeper integration of ESG risks. The final Guidelines clarify how banks should classify, measure and monitor ESG exposures, which not only include climate-related risks but also the risks of biodiversity loss and ESG risks arising within the supply chain.
• More rigorous scenario testing. The EBA is planning more rigorous, standardised and public stress tests, with scenario horizons of over three years. Banks should expect results to be benchmarked, and for ESG scenarios to become a routine topic of supervisory dialogue.
• Plotting clients’ net zero journeys. Banks are making more use of forward-looking tools like alignment assessments. These allow the comparison of national targets with projected sector activity and individual clients’ transition plans – making it easier to respond to policy changes, altered client strategies, and nature-related tipping points.
• Embedding disclosed data: With the first CSRD reports due to be released by firms in 2025, relevant data will begin to become available for banks to integrate into their ESG data frameworks, transition planning, and risk management processes.

Europe’s Significant Institutions (SIs) have spent four years working towards the end-2024 deadline for meeting the supervisory expectations of the ECB’s Guide on climate-related and environmental (C&E) risks. Overall, significant advances have been made, but progress towards full C&E integration varies between institutions . Most banks have established foundational governance, data, and reporting structures, but more work is required by some institutions to embed the management of C&E risks more deeply into risk measurement frameworks and data capabilities, as highlighted in 2024 KPMG market surveys.⁴

The ECB has specified C&E risks as an ongoing area of focus in its supervisory priorities for 2025-2027. Supervisors are not only examining banks’ policies and processes; they are also stepping up scrutiny of actual C&E risk exposures to understand how banks are translating risk insights into real-world decisions - from loan origination to capital planning. In addition, the ECB will continue to apply enforcement measures to banks that fail to meet C&E risk management expectations.

As the ECB’s expectations evolve, European banks are at varying stages of progress. While many SIs have already embedded elements of C&E risks into their frameworks, others may have further to go. For those still developing their capabilities, we would expect them to prioritise the following areas:

• Enhancing ICAAP approaches with quantitative climate risk integration: Banks are moving beyond qualitative discussions to quantitative scenario analysis, capital add-ons and risk appetite metrics - revisiting the ICAAP to factor longer-term climate scenarios into the economic perspective.
• Strengthening the strategic alignment of C&E risks: Banks should continue refining how C&E risks are embedded into risk appetites and lending policies. Examples could include setting thresholds for high-carbon clients, repricing exposures in line with transition risks, and using climate data to identify green financing opportunities.
• Advancing data management: Banks should work on improving C&E data governance. External data providers can fill gaps in coverage of C&E metrics such as sector emissions, energy performance certificates, or climate resilience indicators.

For those LSIs subject to the ECB’s C&E Guide, proportionality applies and deadlines set by their National Competent Authority are generally later than the end of 2024. As a result, many LSIs still have substantial preparation work to complete in 2025 to meet these supervisory expectations. 

Debate over ESG risk management is often portrayed as a choice between regulation and simplification. In fact, effective ESG risk management is vital to resilience and competitiveness – and something that investors and ratings agencies increasingly factor into their models.

There is growing overlap between the need for regulatory compliance and the business case for ESG risk management. Banks that respond to economic case for ESG governance will find it far easier to meet the expectations of the ECB and EBA. Developing capabilities in areas such as scenario analysis, transition planning, data management and capital modelling will help banks prepare for more demanding supervision and respond more effectively to future challenges.