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European Banking Authority focuses on environmental and social risks

The European Banking Authority (EBA), regulator of European banks, has published a new report. This document discusses the impact of environmental and social risks on banks and investment firms and includes suggestions for integrating these aspects more quickly into the existing Pillar 1 framework, the rules that determine how much capital banks must hold.

The Pillar 1 framework is one of the three pillars of the Basel II and Basel III regulations, which set global standards for bank regulation. The EBA states in the new report that environmental and social risks are increasingly coming to the forefront, changing the game for banks. This affects everything from loans and investments to daily operations and can influence both individual banks and the entire financial system.

The report encompasses a host of short-term actions that the EBA recommends implementing over the next three years. These include incorporating environmental risks into stress tests, encouraging the inclusion of environmental and social factors in external credit assessments by rating agencies, and considering these factors in the due diligence and appraisal of real estate serving as collateral. Other suggestions are that banks should consider whether environmental and social issues could directly trigger operational losses and that they should develop environmental-related concentration risk indicators for reporting to regulators.

For the longer term, the EBA report suggests a thorough review of the Pillar 1 framework, especially as environmental and social risks become increasingly critical. They are considering things like using scenario analyses to make the prudential framework more future-proof, the importance of transition plans in further developing risk-based enhancements to Pillar 1, reconsidering whether internal assessment methods and the standard approach to credit risk adequately account for environmental risk, and the idea of introducing special environment-related risk indicators in Pillar 1.

Click here to view the EBA report yourself.