EU banking supervisor, European Banking Authority (EBA) announced the publication of a new report assessing the role of environmental and social risks in its prudential supervision framework for banks and investment firms, including recommendations for the acceleration of these risks across the Pillar 1 framework, which defines banks’ minimum capital requirements.
According to EBA, the new report comes as environmental and social risks are expected to become more prominent over time, changing the risk profile for the banking sector, across financial categories such as credit and market risks, as well as operational risks, and potentially affecting individual institutions as well as the overall financial system’s stability.
The report includes a series of short-term actions recommended by the EBA to be taken over the next three years, including incorporating environmental risks as part of stress testing programs, encouraging the inclusion of environmental and social factors as part of external credit assessments by credit rating agencies, and as part of due diligence requirements and valuation of immovable property collateral. Additional near-term recommendations include requiring institutions to identify whether environmental and social factors constitute triggers of operational risk losses, and to develop environment-related concentration risk metrics as part of supervisory reporting.
On a longer-term basis, the EBA report presents possible revisions of the Pillar 1 framework, in light of the increased importance of environmental and social risks, including the possible use of scenario analysis to enhance the forward-looking elements of the prudential framework, the role of transition plans as part of the development of further risk-based enhancements to the Pillar 1 framework, reassessing the appropriateness of revising the internal ratings based (IRB) supervisory formula and the standard approach for credit risk to better reflect environmental risk, and introducing environment-related concentration risk metrics under the Pillar 1 framework.
The report also indicated that the EBA does not currently support the introduction of a “green supporting factor,” which would reduce prudential capital requirements for environmentally sustainable exposures, or a “brown penalising factor,” which would conversely increase capital requirements for environmentally harmful assets.
About the Authors
Associate Director, Investment Banking
Prachurjya has over 16 years of experience in investment banking with Acuity Knowledge Partners. At Acuity, he has led sector and product-specialist pilot teams across Capital Markets, ESG, Debt Advisory, Loan Syndications, Metals & Mining and Real Estate. He has been actively involved in setting up and on-boarding new ESG Advisory, ESG DCM and Sustainable Finance teams for various bulge bracket investment banks. Within DCM and Rating Advisory, he has been instrumental in helping the clients achieve over 30% in annual savings on both regular and adhoc tasks through standardization of the outputs and deployment of our proprietary BEAT tools.
Delivery Manager, Investment Banking
Puja has 7 years of extensive experience in ESG, Climate Change & Sustainability and she is supervising the ESG team at Acuity. She also has diverse experience in conducting ESIA, EHS compliance audits, ESG Risks and Controls, EHS & ESG Due Diligence assessments. Prior to joining Acuity, she was working with companies like KPMG Global Services, EY India and ERM India. She has expertise in provisioning extensive research requirements for clients through preparation of Peer Benchmarking, Target Compilation, Sustainability report, Sustainable Finance Updates and Sectoral ESG Thematic Detailing Engagement.
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