Banks and climate litigation risk: navigating the low-carbon transition

Over the past decade, climate-related litigation targeted at both public and private actors has mushroomed. This includes some high-profile cases brought directly against banks. Such litigation trends pose material financial risks to banks. In addition, credit institutions need to manage risks related to the rapidly evolving landscape of climate litigation against corporate clients. How banks identify, manage and mitigate these novel legal risks is of strong relevance from the perspective of prudential policy and the effectiveness of transition policies more broadly.

To respond to this challenge, this report investigates how credit institutions engage with climate- and environment-related legal risks. It explains how insights from bank current practice, such as gaps in their legal risk management approaches, should be addressed with targeted prudential policy interventions.

Summary of recommendations

For supervisors:

• Provide clear guidance on how climate-related litigation risks relate to traditional risk categories, including credit, market and liquidity risk, in additional to operational risk. Develop a macroprudential approach to climate litigation risk, especially when it straddles litigation and reputational risk concerns with broader market risk impacts.
• Pay close attention to how banks are conceptualising legal risks in supervisory assessments under Basel Pillar 2, alongside public disclosures, and consider supervisory interventions where significant gaps in understanding are identified.
• Review whether banks are assessing not only actual occurrences of ESG [environmental/social/governance] controversies associated with clients, but also the likelihood of litigation, along with the potential magnitude of the financial impact on the client and the bank.
• Support the development of dedicated sectoral and scenario climate litigation analysis to capture emerging litigation trends that are material from a prudential perspective.
• Establish clear expectations for banks’ risk management processes, accounting for their own litigation risk exposures, but also exposures to litigation against counterparties. This should include expectations relating to internal iterative transition planning processes.
• Increase empirical research into evolving litigation trends and potential implications of litigation on bank safety and soundness, and financial stability.

For banks:

• Monitor climate- and environment-related litigation trends and evaluate these as potential drivers of prudential risk categories, rather than as a siloed, standalone risk category.
• Take steps to systematically identify and assess current and future exposures to litigation risks. This should go beyond understanding cases brought against banks themselves, to include those against counterparties, peer institutions operating in the same jurisdictions, or the governments of jurisdictions in which they have significant exposures.
• Use internal transition planning processes to ensure adequate identification, assessment and mitigation of relevant legal (including litigation) risks. There are elements of private sector transition plans that can help mitigate climate litigation risk.