European banks will have to calculate climate risk in their financial buffer

The innovations introduced by the European Banking Authority

(sustainabilityenvironment.com) – The financial buffer of European banks does not consider climate risk sufficiently. And they have a much higher level of climate exposure than they think. A threat hangs over the entire economy and the ability of countries to absorb and recover from the impacts of the climate crisis.

This is stated by the European Banking Authority (EBA) by introducing new step-by-step measures to mitigate climate risk in the banking sector in Europe. It will not be a system of incentives or penalties for institutions that do not comply. EBA has decided to take a different path and act directly at a more structural level.

Over the next three years, European banks will have to integrate climate risk into the computational models by which they calculate their minimum capital requirements, namely those relating to Pillar 1 of the Basel Regulation. Once this new system is tested and a way of accurately calculating risk levels has been found, EBA does not rule out switching to a bonus-malus system.

read also The ECB has published new climate risk indicators for finance

“The EBA considers, at this stage, that the most consistent way forward from a risk-based prudential perspective is to address environmental risks through effective use and targeted changes of the existing prudential regime rather than through dedicated treatments as support factors or penalizing“, writes the Authority in a note.

Other proposals put forward by EBA to mitigate climate risk in the banking sector already in the short term include the inclusion of environmental risks in stress tests, both under the Internal Rating Approach (IRB) and the Internal Models Approach (IMA). This should also be reflected in external credit assessments by credit rating agencies. In addition, environmental and social factors should be part of the requirements for due diligence and valuation of real estate collateral, whereas institutions should identify whether environmental and social factors are triggers for operational risk losses.

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