The European Banking Authority is revising the framework that sets industrywide capital requirements for lenders – known as Pillar 1 – to incorporate environmental and social risks. — Bloomberg
COPENHAGEN: Banks in Europe will need to adjust the risk assessments they conduct of their clients to reflect new environmental, social and governance (ESG) requirements enforced by their watchdog.
In a world first, the European Banking Authority (EBA) is revising the framework that sets industrywide capital requirements for lenders – known as Pillar 1 – to incorporate environmental and social risks.
Some of the obligations will be enforced immediately, while others will be rolled out over time and will in some cases lead to new legislation, according to the EBA.
For banks, the regime means they’ll have to review default and loss probabilities, as well as the risk weights that go into determining how much capital they set aside for each client account.
The development may have major implications for high-emitting sectors such as oil, gas, cement, steel and mining.
Cracking down on such risks will be “a key area” for banks under the new framework, said Jacob Gyntelberg, director of economic and risk analysis at the EBA.
Current rules already allow banks to “take a forward-looking perspective,” and this is “one of the areas where we should be able to move a little bit faster,” he said in an interview.
Global banking and financial stability organisations are all reviewing reporting and capital frameworks, though none has moved as fast as the European Union (EU) in setting firm requirements.
The Basel Committee on Banking Supervision expects to publish a proposed framework for reporting climate-related financial risks before the end of the year that will help guide regulators across jurisdictions.
The EBA is aware that it’s “the first authority publishing specific suggestions on how to practically incorporate ESG risk considerations into the prudential framework,” Gyntelberg said.
The European Banking Federation (EBF), an umbrella organisation for lender associations across the region, is worried there’s inadequate data to justify imposing Pillar 1 ESG adjustments, rather than so-called Pillar 2 rules, which are specific to individual banks, said Denisa Avermaete, senior adviser at the EBF.
The EBF’s key concern now is that the prudential framework “remains evidence and risk based,” she said.
“It is also crucial that once the EBA considers a more comprehensive revision of Pillar 1 or a macroprudential framework, this is done at a global level to ensure a level playing field for EU banks.”
Gyntelberg said that for financial supervisors, “the Pillar 1 capital process is more disciplined. That’s because banks tend to devote a lot more resources to complying with Pillar 1, which makes it easier to follow as a supervisor”.
Meanwhile, the EBA rejected industry calls for lower capital requirements to encourage lending to companies that invest in technologies to address climate change, or penalties for exposures to heavy polluters.
There remains a possibility that EU lawmakers may be more inclined to heed such calls, according to Nicolas Charnay, senior director and sector lead for EU financial institutions at S&P Global Ratings.
If policymakers find the EBA’s plan doesn’t do enough to reward green activities, “they may disregard the EBA’s concerns and proceed with the introduction of green and/or brown supporting factors, as they have done for the SME and infrastructure exposures,” he said by email.
The plan is unlikely to have immediate ratings implications. — Bloomberg
