The European Banking Authority (EBA) has recently issued a report emphasizing the importance of integrating environmental, social, and governance (ESG) risks into Basel's Pillar 1, which focuses on minimum capital requirements for credit institutions and investment firms.
Through a risk-based analysis, the report explores the effectiveness of the current prudential framework in capturing ESG risks, proposing targeted improvements for the rapid integration of such risks.
This document builds on the principles outlined in the EBA's Discussion Paper released in May 2022, which examined the role of environmental risks in the prudential framework.
Main Objectives:
The core of the proposal is to support the transition to a more sustainable economy while ensuring the banking sector maintains its resilience.
It is evident that ESG risks are shaping the risk profile of the sector, influencing traditional financial risks such as credit, market, and operational risks.
Therefore, it is crucial to consider how environmental and social factors can impact both individual institutions and the overall financial stability of the system.
Challenges in ESG risk assessment:
The report examines current challenges in ESG risk assessment, highlighting:
- The lack of relevant data and a common classification system that hinder the identification and accurate measurement of risks.
- Difficulties in linking physical risks to prudential parameters.
- Criticism of the use of ESG ratings, often of poor quality and transparency.
- The challenging estimation of losses related to environmental and social risks, given the uncertainty surrounding their occurrence and magnitude.
Short and medium-long term proposals:
In the short term, the EBA suggests actions such as:
- Including environmental risks in stress test programs.
- Encouraging the incorporation of ESG factors in external credit assessments.
In the medium-long term, it proposes to review the Pillar 1 framework to better reflect the growing importance of ESG risks, through:
- The use of scenario analysis.
- The reassessment of supervisory formulas.
Conclusions:
The objective is to develop a regulatory framework that aligns better with the long-term manifestation of environmental risks, thereby facilitating a structured transition toward greater sustainability in the banking sector.