EBA Environmental Scenario Analysis Guide 2025: Climate Risk Assessment Framework for EU Financial Institutions

What Is EBA Environmental Scenario Analysis and Why Does It Matter?

Environmental scenario analysis, as defined by the EBA guidelines, is a structured process for identifying and assessing how a range of plausible future states of the world could impact an institution’s strategy and exposure to risks. It builds upon the widely accepted definition from the Task Force on Climate-related Financial Disclosures (TCFD), which describes scenario analysis as a process for identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty.

The EBA environmental scenario analysis guidelines complement the earlier EBA Guidelines on ESG Risk Management (EBA/GL/2025/01) published on 9 January 2025. Together, these frameworks create a comprehensive regulatory architecture for environmental risk management in the European banking sector. The scenario analysis guidelines specifically address the mandate set out in Article 87a(5), point (d) of the Capital Requirements Directive (CRD), requiring the EBA to specify criteria for setting resilience testing scenarios.

The significance of these guidelines cannot be overstated. Environmental risks — including extreme weather events, ecosystem degradation, and mounting pressures on land and water resources — are posing considerable challenges for the economy. As the EBA notes, the impact of acute and chronic physical risk events, combined with the need to transition to a low-carbon, resource-efficient economy, will continue to cause profound economic transformations that directly affect the financial sector.

Scope and Legal Foundation of the EBA Guidelines

The EBA environmental scenario analysis guidelines focus specifically on environmental risks, with priority given to climate-related factors. Social and governance factors have been explicitly excluded from the current scope, as the EBA acknowledges that methodologies for assessing these risks are not yet sufficiently mature. However, future revisions may incorporate social and governance dimensions as frameworks for assessing these risks become more advanced.

The legal foundation rests on several key pieces of EU legislation:

• Article 87a(3) CRD: Requires competent authorities to ensure institutions test their resilience to long-term negative impacts of ESG factors under baseline and adverse scenarios, starting with climate-related factors.
• Article 87a(5)(d) CRD: Empowers the EBA to issue guidelines specifying criteria for setting scenarios, including parameters, assumptions, specific risks, and time horizons.
• Article 177(2a) CRR: Requires IRB Approach institutions to incorporate environmental risk drivers into credit risk internal stress testing scenarios.
• Directive (EU) 2024/1619: The amending directive that introduced enhanced ESG requirements into the CRD framework.

The guidelines apply to all institutions and competent authorities within the scope of the CRD, with application at the level set out in Article 109 of Directive 2013/36/EU. Importantly, the guidelines apply from 1 January 2027, giving institutions approximately 14 months from publication to prepare their implementation strategies.

Two Pillars of Environmental Resilience Testing

The EBA environmental scenario analysis framework is built around a fundamental distinction between two complementary types of resilience testing, each serving a distinct purpose in the institution’s risk management framework:

Short-Term Financial Stress Testing

The first pillar focuses on testing the institution’s financial resilience to severe environmental shocks in the short term, typically covering a horizon of less than five years. This complements the existing EBA Guidelines on Institutions’ Stress Testing (EBA/GL/2018/04) by addressing the specificities of environmental risks that were not previously covered.

In practical terms, institutions must integrate environmental risk factors — identified through their ESG risk management processes — into their stress testing models and consider the results when assessing capital and liquidity adequacy as part of their ICAAP (Internal Capital Adequacy Assessment Process) and ILAAP (Internal Liquidity Adequacy Assessment Process). This requires defining baseline and plausible adverse scenarios that incorporate environmental risks, as well as identifying and modelling the transmission channels through which environmental risk drivers could impact their financial position.

Medium to Long-Term Business Model Resilience Analysis

The second pillar addresses the institution’s business model resilience over the medium to long term. This is a forward-looking tool designed to help institutions navigate a highly uncertain future by scaffolding “What if” hypotheses. It extends the sustainability assessment approach used in the Business Model Analysis under the Supervisory Review and Evaluation Process (SREP).

The resilience analysis requires institutions to assess potential impacts of distinct and plausible scenarios on their business model over a horizon of at least 10 years, encompassing both transition and physical risks. The approach involves projecting key metrics related to profitability, risk, and environmental factors for each business area, first under a reference scenario (the most likely scenario according to the institution) and then under alternative scenarios to test variability and resilience.

Environmental Risk Transmission Channels

A critical component of the EBA environmental scenario analysis framework is the identification and modelling of transmission channels — the pathways through which environmental risks translate into financial impacts. The guidelines require institutions to adopt a structured, well-documented, and regularly reviewed process for identifying these channels.

Institutions must consider both micro-level and macro-level transmission channels, encompassing transition risks (policy changes, technology shifts, market sentiment) and physical risks (acute events and chronic changes). The guidelines specify that environmental risks propagate through several established risk categories:

• Business model and strategic risk: Higher cost of risk and lower profitability driven by environmental transitions or physical impacts on core business activities.
• Credit risk: Counterparty defaults, increased probability of default, and impacts on collateral values — particularly relevant for exposures to carbon-intensive sectors or physically vulnerable locations.
• Market risk: Loss of value of financial assets, increased volatility, and widening credit spreads on environmentally sensitive assets.
• Liquidity risk: Difficulties accessing financing, challenges in liquidating environmentally exposed assets, and increased liquidity needs from customers.
• Operational risk: Sudden or gradual disruptions to business processes, including IT outages and supply chain interruptions caused by environmental events.

Importantly, institutions must also assess indirect exposures — how their counterparties may be affected through their value chains or through spillover effects on local economies. This is particularly relevant for large or concentrated exposures where environmental risks could cascade through interconnected economic systems.

When modelling transmission channels, institutions should also consider risk mitigation or amplification factors, including private and public insurance coverage (while accounting for insurance protection gaps), counterparties’ transition plans and adaptation strategies, and relevant governmental adaptation measures.

Scenario Design Requirements for Climate and Environmental Risks

The EBA provides detailed guidance on how institutions should construct scenarios for their environmental analysis. Scenarios must be credible, based on the most recent scientific knowledge, and grounded in resources from recognised international organisations. The guidelines specify multiple categories of factors that must be considered:

General Factors for All Environmental Scenarios

1. Socioeconomic context: Assumptions about global or regional conditions including population growth, economic development, social inequalities, inflation, monetary policies, and protectionism.
2. Technological evolution: Level and pace of innovation, technology adoption, and infrastructure availability.
3. Consumer preferences: Potential shifts in demand for sustainable, locally produced, or healthier goods and services.

Climate-Specific Factors

For climate risk scenarios, institutions must additionally consider:

• Climate policies: The spectrum from highly ambitious to minimal policy intervention for climate mitigation and adaptation.
• Energy systems: The structure of energy production, consumption, and infrastructure, including the fossil fuel versus renewable energy balance.
• Sectoral decarbonisation pathways: How different sectors transition to net-zero, considering frameworks from the International Energy Agency (IEA), Science Based Targets initiative (SBTi), and Net Zero Banking Alliance (NZBA), as well as EU-specific policies including the European Green Deal and Fit-for-55 package.
• Emissions levels and climate impacts: Greenhouse gas concentrations and their effects on temperature and biophysical processes.

Beyond Climate: Broader Environmental Risk Factors

For environmental risks extending beyond climate change, the guidelines introduce additional scenario dimensions:

• Environmental policy and regulation: Biodiversity conservation, water and air quality regulation, circular economy mandates, and frameworks like the EU Nature Restoration Law.
• Ecosystem condition: Trends in biodiversity, ecosystem degradation, soil fertility, freshwater availability, and pollution levels.
• Land and resource use patterns: Urban expansion, agricultural intensity, mining, and raw material extraction.
• Supply chain ecosystem dependencies: Reliance on ecosystem services such as pollination, water filtration, and raw material availability.

Recommended Scenario Sources and Reference Frameworks

The EBA environmental scenario analysis guidelines strongly recommend that institutions base their scenarios on established frameworks from leading international organisations. For climate risks, the primary recommended sources include:

• NGFS (Network for Greening the Financial System): Provides the most widely used climate scenarios for financial sector analysis, accessible through the NGFS Scenarios Portal.
• IPCC (Intergovernmental Panel on Climate Change): The foundational scientific reference, particularly the Sixth Assessment Report (AR6).
• IEA (International Energy Agency): Valuable for energy system assumptions and sectoral decarbonisation trajectories, though the guidelines note limitations — for instance, the 2024 World Energy Outlook scenarios do not account for physical risks.
• EU JRC (Joint Research Centre): Provides European Commission central scenarios with EU-specific granularity.
• UNEP (United Nations Environment Programme): Broader environmental risk context and data.

For environmental risks beyond climate, institutions should reference the IPBES (Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services), the European Environment Agency (EEA), and the World Resources Institute (WRI), as well as nationally developed science-based assessments.

Critically, institutions must ensure internal consistency across scenarios. Each key factor’s trajectory must be considered in relation to other factors — for example, economic growth assumptions must align with energy demand and technology adoption assumptions. The guidelines also stress that when using external scenarios, institutions should review scenarios from multiple providers to ensure their approach appropriately covers plausible futures.

Proportionality and Progressive Implementation

Recognising the varying capabilities across the European banking sector, the EBA environmental scenario analysis guidelines embed a strong proportionality principle. The degree of sophistication, scope, and frequency of scenario analysis should be commensurate with four key factors:

1. The materiality of environmental risks as determined by the institution’s own risk assessment.
2. The current state of development and maturity of available methodologies and practices.
3. The institution’s internal capabilities, considering its size, business model, and complexity.
4. The expected benefits of the exercise relative to the resources required.

The guidelines establish a tiered approach based on institution size:

• Small and Non-Complex Institutions (SNCIs): May rely on a predominantly qualitative approach for both short-term and longer-term scenario analysis.
• Medium-sized institutions (non-large, non-SNCI): May use sensitivity analysis for short-term financial resilience testing and a predominantly qualitative approach for long-term resilience analysis.
• Large institutions: Expected to implement more sophisticated quantitative approaches, though simplified methods may be acceptable initially for medium-to-long-term resilience analysis and non-climate environmental risks.

The EBA emphasises that institutions should adopt a pragmatic approach, noting that excessive granularity may not lead to better analysis and that an overemphasis on quantification can impair strategic thinking. Balance between credible, comprehensive scenarios and practical utility should guide implementation.

Governance and Cross-Functional Collaboration Requirements

The guidelines place significant emphasis on the governance framework surrounding environmental scenario analysis. Institutions must ensure that scenario narratives are endorsed by senior management and used consistently across the entire organisation. This requirement reflects the EBA’s view that scenario analysis is not merely a technical exercise but a strategic tool that shapes institutional decision-making.

Key governance requirements include:

• Cross-functional collaboration: Multiple departments must contribute expertise and insights to create a comprehensive scenario analysis framework, ensuring consistency of assumptions across business functions.
• Documentation: Institutions must substantiate and document their analyses, including scenario and modelling choices, assumptions made, proxies used for data gaps, factors included or excluded, and main results and conclusions.
• Regular review: Scenarios and narratives must be regularly reviewed, especially when significant changes occur in the business environment.
• Reference scenario coherence: Institutions must define a credible and coherent narrative describing their vision of the most likely evolution of their operating environment. This reference scenario serves as the foundation for all subsequent analysis.

The governance framework should align with the existing EBA Guidelines on Internal Governance (EBA/GL/2021/05) and the EBA Guidelines on ESG Risk Management, creating an integrated governance structure for environmental risk management across the institution. For institutions with significant environmental exposures, the board and risk committees should receive regular reporting on scenario analysis outcomes and their implications for capital planning and strategy.

Specific Requirements for IRB Approach Institutions

Institutions using the Internal Ratings-Based (IRB) Approach for credit risk face additional requirements under the EBA environmental scenario analysis guidelines. Article 177(2a) of the CRR mandates that these institutions integrate environmental risk drivers — particularly physical and transition risks from climate change — into their credit risk internal stress testing scenarios.

For IRB institutions, this means:

• Environmental risk factors must be incorporated into the scenarios used as part of their stress testing programmes, which serve as “challenger models” to the IRB models.
• Both physical risk hazards (acute events like floods and storms; chronic changes like sea-level rise) and transition risk drivers (carbon pricing, regulatory changes, technology shifts) must be reflected in credit risk stress scenarios.
• The selection of specific risk hazards should be based on the institution’s materiality assessment and may differ according to the time horizon being considered.
• Institutions must ensure that their credit risk models can accommodate the non-linear and potentially unprecedented nature of environmental risk materialisation.

This requirement adds an important Pillar 1 dimension to environmental scenario analysis, complementing the broader Pillar 2 requirements under the ICAAP/ILAAP framework. IRB institutions should therefore view environmental scenario analysis as relevant not only for capital planning but also for the ongoing validation and calibration of their internal models.

For further context on the broader EBA risk assessment landscape, explore our analysis of the EBA Risk Assessment Report Autumn 2025, which provides additional insights into the supervisory perspective on environmental risks in the European banking sector.

Limitations and Practical Challenges of Environmental Scenario Analysis

The EBA is notably transparent about the limitations of environmental scenario analysis, dedicating significant attention to ensuring institutions approach results with appropriate caution. Understanding these limitations is essential for effective implementation and for avoiding misguided decisions based on over-interpreted results.

The key limitations identified include:

• Macroeconomic model constraints: Traditional models were designed without environmental considerations and struggle with fundamental economic shifts, limited representation of energy and agricultural systems, and incorporation of feedback loops and tipping points.
• Time horizon uncertainty: The increasing degree of uncertainty as the time horizon lengthens fundamentally limits the precision of long-term projections.
• Data availability: While improving, structured data on environmental risk factors remains limited, particularly for non-climate environmental risks and for granular geographical and sectoral breakdowns.
• Non-linear dynamics: Environmental risks may materialise through compound events, feedback loops, and tipping points that are inherently difficult to model using traditional approaches.
• Assumption sensitivity: Results are heavily dependent on the numerous assumptions embedded in scenarios and models, and “models are only as good as the assumptions that go into them.”

Institutions should therefore avoid overinterpreting results, cherry-picking individual scenarios, or focusing exclusively on low-impact outcomes. When using the scenarios of external parties, institutions should review multiple providers’ scenarios to ensure adequate coverage of plausible futures. The qualitative insights generated through the scenario analysis process — enhanced strategic awareness, identified vulnerabilities, and improved organisational alignment — may ultimately prove more valuable than the quantitative outputs.

Implementation Timeline and Next Steps

The EBA environmental scenario analysis guidelines follow a carefully structured implementation timeline:

• 5 November 2025: Publication of final guidelines (EBA/GL/2025/04).
• 16 March 2026: Deadline for competent authorities to report compliance status to the EBA.
• 1 January 2027: Application date — full compliance required.

However, the EBA expects institutions — particularly large ones and those already advanced in climate scenario analysis — to take proactive measures well before the formal application date. Given that the amended CRD and the ESG Risk Management Guidelines became applicable from 11 January 2026, institutions should already be developing their environmental scenario analysis capabilities.

The EBA also signals that these guidelines represent the first milestones rather than the final destination. Future revisions will consider incorporating social and governance factors, advances from the Basel Committee on Banking Supervision (BCBS) work on climate scenario analysis, NGFS developments on short-term and physical risk scenarios, and industry progress on market risk scenario methodologies for the trading book.

For institutions beginning their implementation journey, the recommended approach is to start with climate-related risks as the priority, leverage existing supervisory stress test exercises as learning opportunities, build gradually from qualitative approaches toward quantitative methodologies, invest in data infrastructure and cross-functional capabilities, and engage with international scenario frameworks (particularly NGFS) as foundations for internal analysis.

For deeper insights into how these guidelines fit within the broader European banking risk management landscape, see our analyses of banking risk management trends for 2025 and the EBA ML/TF Risk Report 2025.

How Libertify Helps You Navigate EBA Environmental Scenario Analysis

Understanding and implementing the EBA environmental scenario analysis guidelines requires navigating complex regulatory text, interpreting technical requirements, and translating them into actionable compliance strategies. Libertify transforms dense regulatory documents into interactive, accessible experiences that help risk professionals, compliance teams, and board members quickly grasp the key requirements and plan their implementation approach.

Our interactive version of the EBA environmental scenario analysis guidelines allows you to explore the full regulatory framework at your own pace, with intuitive navigation, key highlights, and contextual summaries that make even the most technical sections accessible.

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