EU banking supervisor the European Banking Authority (EBA) announced the publication of a new report assessing the role of environmental and social risks in its prudential supervision framework for banks and investment firms, including recommendations for the acceleration of these risks across the Pillar 1 framework, which defines banks’ minimum capital requirements.

According to the EBA, the new report comes as environmental and social risks are expected to become more prominent over time, changing the risk profile for the banking sector, across financial categories such as credit and market risk, as well as operational risks, and potentially affecting individual institutions as well as the overall financial system’s stability.

The report includes a series of short-term actions recommended by the EBA to be taken over the next three years, including incorporating environmental risks as part of stress testing programs, encouraging the inclusion of environmental and social factors as part of external credit assessments by credit rating agencies, and as part of due diligence requirements and valuation of immovable property collateral. Additional near-term recommendations include requiring institutions to identify whether environmental and social factors constitute triggers of operational risk losses, and to develop environment-related concentration risk metrics as part of supervisory reporting.

On a longer-term basis, the EBA report presents possible revisions of the Pillar 1 framework, in light of the increased importance of environmental and social risks, including the possible use of scenario analysis to enhance the forward-looking elements of the prudential framework, the role of transition plans as part of the development of further risk-based enhancements to the Pillar 1 framework, reassessing the appropriateness of revising the internal ratings based (IRB) supervisory formula and the standard approach for credit risk to better reflect environmental risk, and introducing environment-related concentration risk metrics under the Pillar 1 framework.

The report also indicated that the EBA does not currently support the introduction of a “green supporting factor,” which would reduce prudential capital requirements for environmentally sustainable exposures, or a “brown penalizing factor,” which would conversely increase capital requirements for environmentally harmful assets.

Click here to access the EBA report.