ECB could increase capital requirements if banks miss climate goals

March 23, 2022|Written by David Clarke|Banque de France, European Central Bank

Climate capital rules should be linked to banks’ transition plan targets, according to a member of the European Central Bank’s (ECB) governing council. The comments come as ECB officials have reportedly confirmed work on the adjusted rules will commence this year.

According to Bloomberg, several members of the ECB’s supervisory board said they expect to begin discussions following the conclusion of its ongoing climate stress test and accompanying review. They also warned the process of determining the methodology is likely to be contentious, given uncertainty over the pace of warming and a scarcity of data about climate impacts on banks’ balance sheets.

The governor of the Banque de France, François Villeroy de Galhau, argued yesterday that capital rules could be linked with banks’ climate transition plans. He said banks should be required to publish such plans, and that any misalignment with the climate goals included in them could represent a material transition risk, potentially leading to a capital add-on.

However, Villeroy expressed his opposition to any move towards explicitly rewarding or penalising green or dirty lending. He instead argued that climate adjustments to capital rules should be based wholly on an assessment of the risks faced by institutions. This differs slightly from proposals put forward by the Council of Economic Policies and others to calibrate capital requirements based on the climate risk associated with specific asset classes.

The supervisory board members told Bloomberg that one possibility would be to give banks scores that would be factored into their respective capital requirements. The scores could reflect both the volume of their loans to borrowers who face climate issues, as well as the lender’s preparedness in terms of financial reserves and ability to detect and manage risks, they said.

Any move by the ECB to implement climate-adjusted capital requirements is likely to fall under Pillar 2 of the Basel framework, which is tailored to the circumstances of individual institutions. The central bank has previously acknowledged that its current capital regime does not capture climate-related financial risks owing to underlying risk weights that do not yet reflect the full extent of the climate-related risks banks face.

Finance Watch has argued that the difficulties in adequately reflecting climate risks should also be addressed by adjusting the Pillar 1 rules on fossil fuel exposures. This would involve increasing the amount of capital that all major banks have to hold against carbon-intensive lending.

“The current prudential rules do not take into account the risks that climate change poses to financial stability, which effectively equates to a fossil fuel subsidy and steers the economy into the next financial crisis, which will come on top of the climate crisis,” warned Julia Symon, a senior research and advocacy officer at the Brussels-based NGO.

23 March 2022 – this story was amended to add some additional context to François Villeroy de Galhau’s comments on the adjustment of capital rules.

This page was last updated March 23, 2022

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