Making prudential transition plans matter

New European Banking Authority environmental, social and governance risk management guidelines, in force since January 2026, require banks to develop their prudential transition plans.

According to the guidance, banks will need to assess financial risks stemming from misalignments in their portfolios with European Union climate goals. Misalignment can result in transition risk as, misaligned portfolios are more exposed to counterparties that are vulnerable to carbon pricing, new climate policies, litigation risk, technological change and shifts in consumer behaviour.

To manage these risks, banks will have to develop a single, comprehensive strategic planning process over a long-term horizon of 10 years. These requirements are substantial. Implementing them will be a major multi-year endeavour for both banks and supervisors. This is a supervisory priority of the European Central Bank over 2026-28.

Confronting misalignment

The key complication is that the banking sector, and the real economy it finances, are projected to fall substantially short of aligning with EU climate objectives. The European Environment Agency project emissions to fall by roughly half from 2,971 megatonnes of carbon dioxide equivalent in 2025 to 1,511 MtCO2e by 2050. There are many reasons for this.

Banks should not be blamed for the gap between EU policy objectives and EU policy measures. However, banks undeniably have agency in the transition. By channelling financial resources towards companies, projects and assets that align (or misalign) with climate objectives, the banking sector can materially influence the pace and direction of the transition in the real economy. Doing so also reduces their own exposure to the financial risks arising from climate change and the transition towards a sustainable economy.

Nevertheless, while banks still have incentives to set ambitious decarbonisation targets that are consistent with EU policy objectives, they often face fewer incentives to take sufficient action to achieve those targets. Recognising this issue is an important first step to ensure the effectiveness and coherence of the transition planning process. To avoid prudential plans becoming paper exercises, dealing with misalignment head-on will be essential to ensure the effort spent on compliance actually improves resilience. In 2026, supervisors will start to have to deal with the question of how these plans achieve the potential to become effective risk management tools.

Ensuring resilience

First, supervisors need to ensure that banks’ transition planning processes are coherent. The robustness of a transition plan depends on whether a bank is internally consistent in its chosen decarbonisation pathway, whether the bank sets targets that align with EU policy objectives or not. If a bank has targets to align with EU objectives, then a bank should demonstrate that its actions contain incentives (such as favourable pricing and active engagement) to encourage leading counterparties to decarbonise faster than the sectors the operate in are projected to do.

Second, supervisors must ensure that banks are resilient across plausible transition scenarios. If a bank’s targets do not align with EU policy objectives, the bank should be able to explain how its business model would withstand a delayed or disorderly transition scenario.

The Sustainable Finance Lab’s new publication, ‘Making prudential plans matter’ proposes a pragmatic supervisory approach that addresses the challenge around misalignment directly. The publication proposes six supervisory questions that allow supervisors to assess whether transition plans are coherent and decision-useful. These questions examine how banks define their transition objectives, how these objectives relate to EU policy goals, how misalignment is identified and measured, and how it feeds through into risk management, capital planning and strategic decision-making.

This focused approach also aligns with broader EU objectives around regulatory simplification and competitiveness. As supervisors begin to review banks’ transition plans in 2026, the challenge will be to move beyond box-ticking and ensure that these plans genuinely inform risk management and strategic choices.

Making prudential transition plans matter is not about enforcing a single transition pathway, but about ensuring that banks are transparent, coherent and resilient in the face of an uncertain and evolving transition.

Read the full ‘Making prudential plans matter’ paper here.

This article was written by Hesse McKechnie and Gerdie Knijp and published by OMFIF.