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EU Banking Watchdog Calls for Better Climate Risk Assessment by Banks

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Banks Not Fully Reflecting Climate Change Risks, Says European Banking Authority

The European Union’s banking watchdog, the European Banking Authority (EBA), has stated that banks may not be fully considering the risks associated with climate change in their capital buffers. In order to rectify this, the EBA has announced several changes that will be implemented over the next three years.

One of the key changes is the requirement for banks to incorporate environmental risks into the computer models they use to calculate their core capital cushions, known as “Pillar 1” capital. While the EBA is not proposing a fundamental reworking of capital rules at this stage, it has left open the possibility of implementing bespoke capital charges or penalties for climate risks in the future, once a more accurate measurement of their impact is possible.

In a statement, the EBA explained its approach: “The EBA considers, at this stage, that the most consistent way forward from a prudential risk-based perspective is to address environmental risks through effective use of and targeted amendments to the existing prudential regime rather than through dedicated treatments such as supporting or penalising factors.”

In addition to the changes to the capital rules, the EBA is also planning to introduce other enhancements. These include incorporating environmental and social factors into external credit assessments of banks by credit rating agencies, as well as including these factors in due diligence requirements and the valuation of immovable property collateral.

Moreover, banks will be required to identify whether environmental and social factors can trigger operational risk losses, according to the EBA.

Recognizing the importance of accurate data in assessing environmental risks, the EBA emphasized the need to improve the quality of such data. The watchdog plans to develop in-house metrics to help supervise environment-related risks at banks.

It is worth noting that banks already face a requirement to outline their plans for transitioning to a net-zero economy. The EBA now expects these plans to be reflected in the calculation of capital buffers, taking into account the risks associated with climate change.

While more comprehensive revisions to capital rules that reflect climate risks are being considered for the medium to long term, the EBA’s immediate focus is on ensuring that banks adequately account for environmental risks within their existing frameworks.

This move by the EBA reflects growing recognition within the financial industry of the need to address climate-related risks. As climate change continues to pose significant threats to the economy, it is crucial for banks to accurately assess and mitigate these risks in order to maintain financial stability and protect their customers’ assets.

The changes proposed by the EBA aim to strike a balance between addressing the urgency of climate risks and ensuring that prudential requirements are met. By integrating environmental factors into existing capital rules and assessment processes, banks will be better equipped to navigate the challenges posed by climate change and contribute to a more sustainable future.

Sources:
– Reuters
– EBA Statement

More detail via Reuters here… ( Image via Reuters )

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