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EU banking regulator mulls update to capital requirements based on ESG

Groundbreaking report suggests including transition risk in Supervisory Review and Evaluation Process as Malaysian central banks moves on capital requirements for climate risk

The European Banking Authority (EBA) has said that ESG risks should be “incorporated into the supervisory capital assessment” as it prepares to issue guidelines on the topic.

In a report published today on the management and supervision of ESG risks for credit institutions, the EU’s banking watchdog said that it will update the Supervisory Review and Evaluation Process (SREP) Guidelines used by Europe’s financial supervisors to assess risks faced by individual banks. 

The EBA states that the current SREP framework “may not enable supervisors to sufficiently understand the longer-term impact of ESG risks”. To address this, it suggests that a “new aspect of analysis” be introduced to evaluate “whether credit institutions sufficiently test the long-term resilience of their business models against the time horizon of the relevant public policies or broader transition trends”.

It does not state which public policies, but the EU has recently agreed a Net Zero by 2050 climate goal. 

The report says the EBA should “proportionately” incorporate management of ESG risks into the assessment of banks’ governance.

It also says that “at least a 10 year horizon” is needed to assess and capture banks’ exposure to ESG risks, and that regulated financial institutions should use such a timeframe in their own strategic planning. That planning, it added, should be tested against climate different scenarios to test for resilience.

Moreover, it said that ESG risks should be included in the supervisory assessment as “drivers of financial risks, in particular risks to capital and risks to liquidity and funding”, adding that assessment of these risks should be “progressively and proportionally… incorporated into the supervisory capital assessment”. 

The EBA said that any revisions around supervision of ESG risks would give “particular prominence to climate-related and broader environmental risks” at first, but, as firms and supervisors develop their understanding and assessment of social and governance factors, they too will be integrated. 

Meanwhile, yesterday, Malaysian central bank (BNM) Governor Nor Shamsiah Mohd Yunus confirmed that it is exploring ways to incorporate climate risks into its capital requirements for regulated lenders. Such a scheme could see BNM introduce separate prudential treatments for assets based on an assessment of climate risk – for example, by reducing the capital requirements for green assets or increasing the requirements for polluting assets.

BNM governor Nor Shamsiah also indicated that the bank has approved a four-year plan to conduct economy-wide climate stress tests, and is due to finalise new mandatory climate disclosure rules for financial institutions by the end of the year.

Additional reporting by Khalid Azizuddin