Basel Committee releases climate risk principles

The 45 central banks and financial supervisors that make up the influential Basel Committee on Banking Supervision (BCBS) have published their finalised set of principles for managing and supervising climate-related financial risks. Approved last month, the principles are the first formal climate-related guidance issued by the global standard setter for the prudential regulation and supervision of banks.

Largely aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures, the BCBS principles are based on analytical reports and draft principles released last year and were informed by an extensive public consultation process. They form part of an ongoing BCBS assessment of potential climate-related measures covering disclosure, supervision and regulation.

The first 12 principles are aimed at banks and cover corporate governance, internal controls, risk assessment, management and reporting, capital and liquidity adequacy and other elements of risk management, including scenario analysis. Banks should incorporate material climate-related financial risks into their internal capital and liquidity adequacy assessments (Principle 5), and should understand the impact of climate-related risk drivers on their liquidity risk profiles (Principle 10).

The remaining six principles focus on financial supervisors and regulators, outlining their duty to ensure that banks can “adequately identify, monitor and manage all material climate-related financial risks.” Supervisors are expected to know the extent to which banks identify and assess their climate-related risks and, if needed, to “utilise an appropriate range of techniques and tools and adopt adequate follow-up measures in case of material misalignment with supervisory expectations.”

Designed to accommodate a diverse range of banking systems, the principles attempt to find a balance between providing a common international baseline and the flexibility needed in this evolving area. They are aimed at large internationally active banks and financial authorities in Basel Committee member jurisdictions.

Initial civil society response to the BCBS principles was mixed. “On the positive side, the finalised version of the principles has a few clarifications, which add robustness to the supervisory approach,” said Julia Symon, head of research and advocacy at Finance Watch. Symon also welcomed the distinction made between financially conclusive stress tests and more exploratory scenario analyses.

However she was clear that the current guidance was just a first step. “The Principles remain generic and mostly high level and recognise that supervisory and banks’ own risk management practices will take time to mature,” she said.

“As climate-related risks are of systemic nature and grow with time, more impactful and immediate measures are needed. We expect the Basel Committee to come out with further stronger measures on the results of its holistic review of the Basel framework.”

Pierre Monnin, senior fellow with the Council on Economic Policies, also welcomed the BCBS principles but warned of the lack of an enforcement mechanism. “Experience from most advanced jurisdictions shows that financial institutions are far from meeting climate risk management supervisory expectations,” he told Green Central Banking, pointing to an ECB assessment that no bank is close to meeting its climate-related supervisory expectations.

“BCBS recommendations should also guide supervisors on how to act when such gaps are acknowledged,” he said, adding that this is missing in the current principles.

“The BCBS should highlight options for supervisors to complement supervisory expectations with regulatory measures – like Pillar 2 capital requirements – when supervised institutions do not fulfil expectations in terms of climate financial risk management,” Monnin recommended.

“The BCBS principles are also mute on how supervisors should manage systemic risks posed by climate change and the transition. Macroprudential options should be suggested as climate is now widely recognised as a systemic risk for the financial system.”