The European Banking Authority (EBA) published a Discussion Paper on the role of environmental risks in the prudential framework for credit institutions and investment firms. The Paper explores whether and how environmental risks are to be incorporated into the Pillar 1 prudential framework. It launches the discussion on the potential incorporation of a forward-looking perspective in the prudential framework. It also stresses the importance of collecting relevant and reliable information on environmental risks and their impact on institutions’ financial losses. The consultation runs until 2 August 2022.

Environmental risks are changing the risk picture for the financial sector and will become even more prominent going forward. This affects all traditional risk categories, such as credit, market and operational risks. It also raises the question as to whether the current prudential framework can account for these new risk drivers.

The Discussion Paper provides an analysis of the extent to which environmental risks are already reflected in the Pillar 1 own funds requirements via internal and external ratings, valuation of financial instruments and collateral, or scenario analysis.

When considering the introduction of a dedicated treatment of environmental risk drivers, one first needs to evaluate the extent to which these are already reflected in the prudential framework. To the extent that environmental risks are already captured in the prudential framework, any further adjustment should be designed in a way that avoids double counting, to ensure the framework’s consistency and robustness.

The Paper takes a risk-based approach to ensure that the prudential framework reflects underlying risks and supports resilience of financial institutions. The purpose of the prudential framework is not to achieve specific environmental objectives. These could be supported by the risk-based framework, particularly if coupled with other policy actions.

While the Discussion Paper focuses on Pillar 1 own funds requirements, it highlights the need for a holistic regulatory approach and should be seen as part of the EBA’s broader work in the area of ESG risks, which includes transparency, risk management, Pillar 2 supervision and macroprudential capital buffers. The Paper also highlights interlinkages with the accounting framework.

Stakeholders are invited to provide their feedback on the analysis in this DP, which will be used by the EBA in finalising its report on the topic.

Source: EBA