• The EBA requires banks to use environmental scenario analysis from 2027

• Institutions must test resilience to physical and transition climate risks

• Scenario analysis will assess both short-term capital impacts and long-term business viability

• Environmental risks must be modelled as drivers of credit, market and liquidity risks

• Proportionality allows smaller banks to use simplified, qualitative methods

• The EBA calls for credible data, governance and transparency in scenario design

• Guidance emphasises cooperation with authorities and cross-sector data sharing

• Results should inform capital planning and transition strategies

• Banks must identify transmission channels of climate risk to financial exposure

• The process should encourage strategic reflection, not just quantitative outputs

The European Banking Authority has published its final Guidelines on Environmental Scenario Analysis, requiring banks across the European Union to integrate climate and environmental factors into their risk management and stress testing frameworks.

The EBA said in its guidance that scenario analysis is “a highly valuable tool for anticipating risks, enhancing preparedness and seizing emerging opportunities.” 

It described environmental risks such as extreme weather events, ecosystem degradation and resource pressure as major challenges to financial stability and business continuity.

From 1 January 2027, institutions must use environmental scenario analysis to test both their short-term financial resilience and the long-term adaptability of their business models to environmental shocks. 

The EBA in its guidance stated that the approach “should enable institutions to assess and, where necessary, adapt their strategy and business model to mitigate environmental risks, while also seizing related opportunities.”

The guidelines apply to all credit institutions and investment firms, with proportionality allowing smaller entities to adopt simplified methods such as qualitative or sensitivity analysis. 

Larger institutions using internal ratings-based models will need to incorporate environmental risk drivers directly into their credit risk stress tests under the Capital Requirements Regulation.

Environmental scenario analysis, according to the EBA, should cover both physical and transition risks. 

Physical risks include the financial impacts of heatwaves, floods and rising sea levels, while transition risks arise from policy, technology or market shifts linked to decarbonisation. 

The authority said institutions must “define credible baseline and adverse scenarios” and identify transmission channels through which environmental risks affect loan books, market positions and operations.

The EBA in its guidance advised that banks should base their scenarios on authoritative sources such as the Intergovernmental Panel on Climate Change, the Network for Greening the Financial System and the International Energy Agency. 

These sources provide pathways for temperature change, energy transitions and sectoral adaptation that can be tailored to individual business models.

Governance is a central pillar of the framework. Institutions are expected to embed environmental scenario analysis across business lines and ensure oversight by senior management. 

Documentation of assumptions, data sources and modelling approaches must be clear and consistent. 

“Institutions should substantiate and document their scenario analyses, including the assumptions made and the main results and conclusions reached,” the EBA said.

While the guidelines focus primarily on climate-related risks, they acknowledge that broader environmental threats - such as biodiversity loss, resource scarcity and disease outbreaks - will be incorporated in future updates. 

The EBA urged banks to prepare to widen their analytical scope as methodologies mature and data quality improves.

The authority also cautioned institutions against over-interpreting the results of scenario analysis. 

Models built on macroeconomic assumptions may not fully capture the complex feedback loops and tipping points inherent in environmental systems.

“Scenario analysis is designed to inform, not dictate, decision-making,” the EBA said, stressing that the exercise should promote strategic reflection and cross-functional collaboration rather than deliver precise forecasts.

Competent authorities will begin assessing compliance two months after the official translation of the guidelines is published. 

The EBA expects banks to progressively enhance their capabilities in the lead-up to 2027, working closely with supervisors and sharing expertise across the sector.

Ultimately, the EBA said, environmental scenario analysis should become a standard feature of risk management and corporate strategy.