EBF SUSTAINABLE FINANCE ROUNDUP ARTICLE

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‘Getting to grips with managing climate risk’, Lukas Bornemann, EBF Prudential Policy & Supervision Policy Adviser 

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BRUSSELS, 17 March 2022 –  In November 2021, the Basel Committee on Banking Supervision (BCBS) issued a consultation on the “Principles for the effective management and supervision of climate-related financial risks”. This is a significant enhancement in the scope of the BCBS global standards, only comparable to the addition of market risk in the 90’s, operational risk in the 2000’s or liquidity risk in the 2010’s. The Basel Committee will define, in a high-level and principle-based manner, what banks and supervisors should look out for when discussing the topic of climate risk. In its consultative document, the BCBS has laid out principles that apply both to banks and supervisors in a qualitative manner. The principles range from corporate governance aspects, such as implementing processes that allow banks to properly understand and assess their climate risk, guidance on the integration of climate risk in their capital and liquidity adequacy frameworks, to scenario analysis that would be used to assess banks’ resilience to climate risk. Furthermore, the BCBS has taken the opportunity to also address supervisors who will need to ensure that the BCBS principles are respected by their supervisees. 

Considering the global nature of the climate risk challenge, the BCBS is the right institution to adopt a supranational approach for the banking sector, thus pursuing a coordinated approach for example concerning the reporting and disclosure of information. With a broader view on harmonization, it is important that supervisors have the necessary flexibility to reconcile the BCBS principles with their own expectations. Many supervisors have already progressed on this and developed their own expectations and communicated them to the banking sector. Therefore, the mentioning of proportionality in the consultative document is quite relevant. At the same time, it would be preferable that the discussions within national jurisdictions feed back into the discussions at the BCBS and inform the future regulatory output of the BCBS. 

The main challenge for regulators and supervisors in the next years will be finding the appropriate treatment of climate risks in banks’ capital and liquidity frameworks. It looks like policy makers will be faced with a conundrum that is not easy to resolve. On the one hand, everyone agrees that climate risks will appear in the future and that they will have an impact on banks’ clients. On the other hand, the transition towards a more sustainable economy is already underway. However, what is not clear is how exactly the risks will be materializing.  

The key persisting issue is the lack of data as to how this will play out. First, there is uncertainty around the physical aspect of the climate change challenge. While it is certain that it will happen, two questions remain, which are “How?” and “When?”, referring to the speed and magnitude, and the non-linearity of the impact. Second, there is the regulatory uncertainty that banks are faced with, and which leaves questions about key aspects of the overall issue, most importantly about the policies governments will choose to fight climate change. Third, there is a complex sum of interplaying factors that need to be understood, such as the transformation capacities of the industry, public and industrial policies supporting transition, general economic, social and political developments such as inflation, or the availability of certain raw materials or technological developments. However, more information on this would be needed to define general quantitative rules and expectations for capital charges, which tend to be the outcomes of careful calibrations. In this respect, a more appropriate solution will be to maintain the dialogue between supervisors and banks and use available tools, like the ECB climate risk stress test or the thematic review, to develop a deep understanding of the impact of climate risk on banks and take the necessary measures if climate risk is not accounted for appropriately. 

What is also clear is that banks alone will not be able to bring about the so-called “greening” of the economy on their own. Banks are an important piece in the overall puzzle, but it should not be forgotten that in the case of the EU, the member states will need to integrate their fight against climate change into their overall policy objectives. Such clarity from the public sector will be essential for banks to be able to take up their commitments within the confines of the societal compromise that is reflected in EU member states’ climate objectives. 

You can read the EBF’s official response to the BCBS Consultation ‘Principles for the effective management and supervision of climate-related financial risks’ here. 

For more information:
Lukas Bornemann, EBF Prudential Policy & Supervision Policy Adviser, l.Bornemann@ebf.eu

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About the EBF:

The European Banking Federation is the voice of the European banking sector, bringing together national banking associations from across Europe. The EBF is committed to a thriving European economy that is underpinned by a stable, secure and inclusive financial ecosystem, and to a flourishing society where financing is available to fund the dreams of citizens, businesses and innovators everywhere.