EBA backs away from supporting, penalising factors in preliminary analysis

Final policy recommendations on the topic are due to be delivered to the European Commission by 2023.

The European Banking Agency (EBA) has poured cold water on the proposed use of dedicated prudential treatments for assets based on their climate exposure.

Such a mechanism would allow supervisors to reduce the amount of capital banks are required to set aside for green assets or conversely increase the requirements for polluting assets – known as introducing a green supporting factor or a brown penalising factor, respectively. Although such a policy has been mooted for some time, it has yet to be implemented by policymakers anywhere in the world.

The EBA’s opinion on the measure is significant as it has been tasked with exploring whether there is any evidence to support the implementation of supporting or penalising factors on the basis of environmental and social performance. The EBA has until next year to deliver its findings to the European Commission.

According to a discussion paper published yesterday, the EBA said that the proposed measure “could undermine the credibility, suitability and efficiency of prudential tools, hindering the ability of these rules to meet their primary objectives of ensuring safety, soundness and financial stability”.

Deviating from international prudential standards could also weaken them and “tilt the level playing field” for global banks, it said.

The EBA warned that incentivising investments towards green activities could cause financing risks at counterparties that are not competitive and lack credible long-term strategies. Restrictions on financing carbon-intensive industries could also limit the funding available for key transition activities needed to decarbonise, it added.

The EBA said it had taken a risk-based approach in its analysis to ensure that prudential requirements reflect the underlying risk profiles of institutional exposures but noted there was limited evidence of a risk differential between green and environmentally harmful assets.

“It appears that targeted amendments to the existing prudential requirements would address these risks more accurately than dedicated treatments such as supporting or penalising factors, given the various challenges associated with the design and implementation of such factor,” the EBA concluded.

Suggested measures include enhancing environmental risk-related data collection and ensuring that institutions’ risk management tools and practices explicitly consider environmental risks.

It is important to note that the discussion paper is very limited in scope. It specifically addresses Pillar 1 capital – the minimum capital banks need to set aside to cover core risks – rather than the entirety of the prudential framework, and gives limited consideration to social performance. However, it could give an early indication of where the EU is heading on the topic.

“The interim findings in this discussion paper do not constitute definitive policy recommendations and do not pre-empt the EBA’s final report,” the regulator said. “In this final report, the EBA will pursue the analysis set out [here], taking into account feedback received as well as insights gained from available data and policy developments at the EU and international levels, before formulating its policy recommendations.”

Stakeholders have until 28 July to respond to the discussion paper.