April 11, 2021

Supervisors pressure banks to understand their exposure to climate risks in depth

NPL ratio, efficiency ratio, capital ratio, ratio of deposits to loans, solvency ratio … Banks are obliged to calculate a multitude of equations such as those mentioned that serve to show different information on the quality of their balance. They could be joined next year by a new one: the green asset ratio. This has been proposed by the European Banking Authority (EBA), which has launched a public consultation to develop this proposal, aimed at knowing how many of the assets that a bank has are aligned with the objectives of the Paris Summit.

Peru Sasia and Daniel Sorrosal: "There is a very established 'greenwashing' in banking, sustainability goes beyond green"

Peru Sasia and Daniel Sorrosal: “There is a very established ‘greenwashing’ in banking, sustainability goes beyond green”

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The proposal was made public this Monday by the European banking supervisor, led by the Spanish José Manuel Campa. The GAR, as this index has been called, seeks to have detailed information on this type of assets and with a structure that makes it comparable with other entities. Thus, institutions should disclose their GAR ratio to show to what extent the financing activities in their bank portfolio (including loans and advances, debt securities and equity instruments in the bank portfolio) are associated with economic activities aligned with the EU classification. and therefore with the Paris Agreement.

The initiative announced this Monday follows other processes by European banking supervisors, who have put knowledge of the climate risks of financial institutions at the center of their supervision objectives for the coming years. European banks, especially those of larger size, are currently preparing for the EBA itself to assess its resistance to climate risks next year, in 2022. The famous resistance tests or stress tests, as they are known, will be in the next year exclusively to know how the balance sheets of financial institutions would hold up to various different scenarios of the evolution of the climate crisis.

“In line with the growing importance of climate change to the economy and growing evidence of its financial impact on banks, the ECB will conduct its next supervisory stress tests in 2022 on the basis of climate risks,” the ECB noted in autumn by announcing that these tests would be carried out on the relevant European banks. Entities will have to take into account risk factors such as extreme weather events, chronic weather patterns, pollution, loss of biodiversity or environmental policies and regulations.

The European financial sector is currently focused on getting out of the economic crisis caused by the coronavirus and during the coming months, until the summer, they are being analyzed by the EBA and the ECB in the stress tests that will be published in July and that were delayed last year. These periodic tests seek to know how the balance of a bank will evolve in the face of different scenarios of economic evolution after the pandemic and if they could withstand the most adverse hypothesis if it lasts longer than expected. These examinations are used so that, later, specific recommendations can be made to each entity. Among the Spanish entities, Santander, BBVA, Sabadell and Bankinter take this exam, while CaixaBank and Bankia are fought for being immersed in the merger. The rest will be studied by the ECB but their results will not be made public.

However, banks are not forgetting next year’s exercise and, as market sources point out, they are waiting for the EBA to publish how the resistance exercises will be in the face of climatic risks that they will undergo in the tests 2022 stress crisis. The environmental crisis is among the main risks, if not the most prominent, facing the financial system in the coming years and, from different spheres, there has been pressure for banks to work to adapt their portfolios of credits and asset management towards those sectors that reduce the carbon footprint.

More risks than with other possible crises

In a recent report, the Financial Stability Board, a body that unites the central banks of the world’s major economies, warned that climate risks are the most important facing the global financial system. The agency’s report noted that “the breadth and magnitude” of climate-related risks could cause its effects were “more pernicious than in the case of other economic risks”.

The organization, in which the Bank of Spain participates, stressed that the impact of any catastrophe linked to the weather can translate into a risk for the financial system, with a possible contagion beyond the area where this event occurs, due to the great geographical interconnection that the sector now has. These risks were “amplified”, according to the FSB, due to the lack of in-depth information available on the exposures of banking entities – and other players in the financial industry – to the most affected sectors. “While the proportion of companies that clarify their information on the climate has grown in recent years, it is still quite low in absolute terms,” ​​the FSB said in its report and called on the authorities to create regulations that would bind this. transparency. In a survey of banks around the world, only 12% give details about their analyzes of the different climate scenarios, the report pointed out.

The ECB also took a position on this idea in a report presented a few days before that of the FSB. The body headed by Christine Lagarde pointed to the lack of disclosure of climate and environmental risks by European banks. “Although there has been some improvement over last year, banks need to make significant efforts to better support their disclosures with relevant quantitative and qualitative information,” he noted.

This is the glove that the EBA collects, who points out that it has based on the working group created by the FSB to address this issue and develop its proposal to know the ratio of green assets of European banks. “The GAR is important to set strategies so that a bank with a low GAR can identify how it wants to change its financing activities in time to achieve the objectives of the Paris agreement, as well as the measures to follow this strategy”, pointed out the EBA in the documents published this Monday.

To date, all the main financial institutions have been making progress and announcements in this regard under pressure not only from environmental defense organizations but also from their own shareholders. The position of Blackrock, a shareholder in all the main Spanish banks and with a wide presence in the Ibex35, is well known, which with different communications has called for the assumption of changes in financial activity to reduce financing to those sectors that are more polluting and linked with carbon emissions. However, all these advances do not have a tool so that both clients, shareholders or authorities, could measure and compare the progress.

It is at this point that the EBA has an impact with its proposal to use the GAR. “This information is relevant to understand how institutions are working to mitigate their risks linked to climate change by financing activities that contribute to climate objectives,” says the EBA in the public consultation it has opened. Thus, the supervisory body intends that this, and other tools that it proposes, serve to provide “significant and comparable” information regarding the climatic risks that entities face, providing “transparency” on the actions taken in this via.

Three year term

In its development over the next few years, the GAR must account not only for the business financing activity of banks but also for loans to households. For example, the mortgage portfolio should take into account the energy efficiency of the houses whose purchase is financed or if credits are granted for the improvement of houses. In the same way, it opens the door to be informed about the efficiency of the vehicles from which your purchase has been financed.

The EBA’s strategy goes beyond the GAR, although it is the most innovative instrument, since the public consultation that was opened this week aims to create a range of both quantitative and qualitative information on the situation of banks’ balance sheets. offering a comparable framework for all supervised entities. “The proposed indicators, in particular the green assets index, will help stakeholders to understand the path of entities towards sustainability and financing activities compatible with the Paris agreement,” says the body chaired by Campa.

In addition to the public consultation opened by the EBA, the agency has sent the proposal to the European Commission, who had previously consulted the banking supervisor on methods to give environmental transparency to the activity of the financial system. In this proposal, it proposes that a time be given until the end of 2022 for the calculation of the GAR for large companies and until June 2024 for the rest.


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