Prudential Transition Plans

What's Next After the Adoption of the Capital Requirements Directive?

March 12, 2024Published by Institute for Climate Economics

The EU has made a “major step forward” by incorporating transition planning into its reformed capital requirements framework, however a broader definition of transition plans is needed, says this policy paper for the Institute for Climate Economics.

The capital requirements directive (CRD), which integrates Basel 3 framework into EU law, will require banks to draw up prudential transition plans. The EU has left the responsibility to precisely define the contents of such plans to the European Banking Authority (EBA).

The EBA is holding a consultation on its CRD-related guidelines which will run until 18 April. This policy paper by Julie Evain analyses the EBA’s proposals and makes recommendations to improve them.

Prudential transition plans should, according to this paper, “encourage banks to reflect on and transform themselves in light of climate issues” in order to prepare them for the “new climate reality”.

The advantage of incorporating transition plans into the prudential framework is that it moves beyond reporting guidelines and enables financial supervisors to monitor the implementation of plans and impose sanctions for noncompliance. Frank Elderson, ECB executive board member, has mentioned possible fines of 5% of banks’ daily net banking income for non-compliance.

Overall, Evain states the EBA’s proposed definition is too focused on short-to-medium term risk management.

Evain calls for a broader approach which aims to achieve climate neutrality by 2050 and encapsulates methods for reorienting bank activity towards transition positive investments, in addition to climate risk management. Evain also states that the EBA’s definition should include sectoral and interim emissions targets.

These elements are essential for long-term economic transformation as well as consistency with the rest of the European regulatory architecture, in particular the corporate sustainability reporting directive and corporate sustainability due diligence directive, says the author.

The paper goes on to identify four key issues which must be addressed in banks transition plans to enable structural transformation of the sector:

  1. real economy effects – design plans to account for effects on, and interaction with, real economy factors, by basing plans on EU and national objectives and by ensuring banks have strategies to restrict financing only to companies with robust plans;
  2. variable remuneration – ensure renumeration schemes are consistent with the implementation of the plan at management and operational levels;
  3. capacity testing – by including transition plans in Pillar 2 ,supervisors have the power to activate “fit and proper tests” which they should use to assess if appropriate training is in place to build a pool of suitably qualified people to implement plans;
  4. broader concept of stranded assets – include more sectors outside of fossil fuel infrastructure, such as agriculture, real estate, industry and tourism in analysis of stranded assets.

This page was last updated March 12, 2024

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