Finance sector divided over Basel climate risk proposals

A consultation exercise run by the Basel Committee on Banking Supervision (BCBS) has revealed divergent views within the finance sector over how regulators should address climate-related risks.

Some respondents – such as the banks and policy experts that make up the Climate Safe Lending Network (CSLN) – recommend that the committee promotes the use of climate-adjusted capital requirements.

On the other end of the spectrum, the American Banking Association (ABA) suggests that no further regulatory action should be taken at this stage. However, this appears to be a controversial position based on the submissions that are publicly available.

The BCBS asked for feedback on a draft set of principles, which are set to provide a baseline for banking regulators’ approach to climate in the coming years. The principles are largely aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures, and cover areas such as corporate governance, disclosure and scenario analysis.

The CSLN has called the proposals “sensible but timid”, and has argued for a more comprehensive regulatory toolkit. This includes a ‘one-for-one’ rule, which would increase the capital banks must hold against loans toward new fossil fuel projects to 1250%, obliging them to finance such projects solely from their own funds.

Capital rules fall under Pillar 1 of the Basel Framework. Other respondents have suggested that regulators should use tools that fall under Pillar 2, which exists to reinforce the first pillar, and includes capital add-ons and stress tests. The trade body UK Finance points out that supervisors are not currently using all of the Pillar 2 tools they have available.

The ABA, on the other hand, says it would be premature and counterproductive to attach regulatory consequences to banks’ climate risk exposures. A letter from the group recommends that until such risks are better understood and more market data is available, quantitative assessment and review should be performed using banks internal models and processes.

Ironically, it is precisely due to the shortcomings of banks’ internal processes that the CSLN argues such risks must be mitigated via climate-adjusted capital rules.

The CLSN’s submission says that addressing climate through Pillar 1 measures “would remove the burden on banks to try and incorporate uncertain and forward-looking climate-related risks with little historical data into internal models that are not designed for – or suited to – modelling climate risk”.

This is echoed by the Brussels-based NGO Finance Watch, which says the BCBS must adopt a double materiality approach towards climate risks. This means regulating to address banks’ impacts on the climate as well as the risks they face from it. The group argues that capital rules could be used to break a ‘doom loop’, whereby banks finance fossil fuels, which contributes to warming, leading to knock-on effects on financial stability.

There is some agreement among the submissions about the need for greater clarity over the difference between scenario analysis and supervisory stress testing. For example, the International Swaps and Derivatives Association says it understands stress testing to be a tool to assess capital adequacy, whereas scenario analysis could be used to inform a bank’s wider strategy.