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A new set of EU rules is poised to come into effect on 1 January which creates new expectations for banks to report risks to their financial stability from climate threats. Here’s a guide to all the essentials on how the capital requirements regulation (CRR) will affect banks operating in the EU, including those headquartered elsewhere.
1. Why is this happening now?
The revised capital requirements regulation, which applies from 1 January, is part of a package of legislation that implements the Basel 3 framework into European law, which is aimed at making sure banks are sufficiently capitalised to prevent another financial crisis.
It includes the requirement that ESG risks are included in banks’ internal calculations for assessing whether they are holding enough capital.
“The economy needs stable banks particularly as it goes through the green transition. It is in turn crucial for banks to identify and measure the risks arising from the transition towards a decarbonised economy,” Frank Elderson, executive board member of the European Central Bank (ECB), said earlier this year. “While quantifying the risks is challenging, it is far from impossible.”
The ECB says over 80% of euro area banks have already concluded that transition risks have a material impact on their strategies and risk profiles.
However, the CRR – like the Basel framework – does not require that banks apply different risk weightings to their loans depending on the climate impact they might have.
“There is no immediate requirement to apply a supporting or penalising factor … to take account of the impact of ESG factors,” according to law firm Clifford Chance.
The EU approved the CRR along with a revised capital requirements directive which requires banks to create plans to address climate-related and environmental risks. Supervisors will monitor these plans and can require banks to reduce their exposure to these risks. However, most of this directive only applies from January 2026.
2. What is the main impact of the CRR?
Banks will have to increase their reporting to regulators on ESG risks, as well as on market risk and exposure to crypto assets. The CRR demands that banks submit this data to the European Banking Authority (EBA), which will publish it on a data hub.
This disclosure requirement will apply to all institutions, even small banks, but the EBA is due to support small institutions by helping them generate the necessary disclosures. The EBA will draft implementing technical standards for these disclosures by July 2025.
Banks will have to disclose their exposure to the fossil fuel sector and how they integrate ESG risks in their strategy and processes, as well as governance and risk management. Large banks will have to report twice a year, while smaller ones only have to report once a year.
The CRR also includes harmonised definitions for terms such as “environmental risk” which it describes as “the risk of losses arising from any negative financial impact on the institution stemming from the current or prospective impacts of environmental factors on the institution’s counterparties or invested assets, including factors related to the transition towards certain environmental objectives”.
3. What does this mean for banks’ risk management?
Some observers argue that this regulation will have minimal impact because it does not affect the banks’ financial incentives to invest in climate-friendly projects. “There is nothing binding. It’s only disclosure,” said Philippe Ramos, advocacy officer from campaigning group Positive Money, pointing to the Basel Pillar 3 rules which lay out the public disclosures banks are required to make. “It won’t incentivise banks to invest that much in climate-friendly projects.“
However, consultancy firm PwC said that disclosure obligations could shift banks’ behaviour: “CRR III will change how a bank views the risk – and hence also the relationship between risk and return – of its products, customers and business lines. The impact of CRR III will depend on the respective bank’s business model and regulatory approach.”
4. How does this compare with what other jurisdictions are doing?
It looks unlikely that the Federal Reserve and other US regulators will back the Basel framework which asks banks to disclose their climate risks, meaning that EU banks will face tougher disclosure requirements than their US counterparts. However, global banks operating in the EU will presumably still have to comply, said Ramos.
Meanwhile, US firms also have to take into account a new set of state laws in California which requires disclosure of greenhouse gas inventories for companies doing business in California with annual revenue over US$1bn.
5. What might happen next?
More legislation to tighten these capital rules could eventually emerge.
Clifford Chance notes that the regulation will require the EBA to re-assess whether environmental or social factors should have an impact on the risk weighting of assets and liabilities.
The CRR requires the EBA to report by the end of 2024 on the feasibility of introducing a standardised methodology to identify and qualify ESG risks. By the end of 2025, it should report on how risky ESG investments are compared to other exposures and what would be the impact on financial stability and bank lending of treating them in a different way.
Ramos noted that some environmentally-friendly investments – such as in better insulated buildings – might be less risky as they could be more resilient to energy price fluctuations. And fossil fuel projects could be more risky for banks because they could become stranded assets due to environmental legislation. However green projects are not intrinsically less risky so “It is very difficult to prove the right capital charge,” Ramos said.
The EBA also has to report to the European Commission in July 2025 on whether ESG risks are properly reflected in how credit rating agencies measure risk.
This page was last updated December 5, 2024
Written by
Emma Thomasson is a British journalist, consultant and trainer based in Berlin. She is an expert in economics, politics, business and technology. She previously worked for Reuters as a correspondent and bureau chief in Germany, Switzerland, the Netherlands, South Africa and the UK.
