EBA unveils paper on environmental risk role in prudential framework

The European Banking Authority (EBA) has launched a discussion paper on the role of environmental risks in the prudential framework for credit institutions and investment firms.

According to the EBA, the paper explores whether and how environmental risks are to be incorporated into the Pillar 1 prudential framework.

In addition, the paper also launches the discussion on the potential incorporation of a ‘forward-looking perspective’ in the prudential framework as well as stressing the importance of collecting relevant and reliable information on environmental risks and their impact on institutions’ financial losses.

The EBA said, “Environmental risks are changing the risk picture for the financial sector and will become even more prominent going forward. This affects all traditional risk categories, such as credit, market, and operational risks. It also raises the question as to whether the current prudential framework can account for these new risk drivers.”

The discussion paper, the Authority claims, provides an analysis of the extent to which environmental risks are already reflected in the Pillar 1 own funds requirements through internal and external ratings, scenario analysis and valuation of financial instruments and collateral.

The EBA added, “The Paper takes a risk-based approach to ensure that the prudential framework reflects underlying risks and supports resilience of financial institutions. The purpose of the prudential framework is not to achieve specific environmental objectives. These could be supported by the risk-based framework, particularly if coupled with other policy actions.

“While the Discussion Paper focuses on Pillar 1 own funds requirements, it highlights the need for a holistic regulatory approach and should be seen as part of the EBA’s broader work in the area of ESG risks, which includes transparency, risk management, Pillar 2 supervision and macro-prudential capital buffers. The Paper also highlights interlinkages with the accounting framework.”

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