Banks may not be fully reflecting risks from climate change in their capital buffers and several changes will be introduced over the next three years to help rectify this, the European Union's banking watchdog said on Thursday.
The European Banking Authority said it would require banks to input environmental risks into the computer models they use to calculate core, mandatory "Pillar 1" capital cushions.
No fundamental reworking of capital rules is being proposed, but the door is left open to bespoke capital charges or penalties for climate risks at a later stage, once it becomes clearer how the capital impact of this risk can be accurately measured.
"The EBA considers, at this stage, that the most consistent way forward from a prudential risk-based perspective is to address environmental risks through effective use of and targeted amendments to the existing prudential regime rather than through dedicated treatments such as supporting or penalising factors," it said in a statement.
Other "enhancements" to capital rules include adding environmental and social factors to external credit assessements of banks by credit rating agencies.
The EBA also wants to include environmental and social factors as part of due diligence requirements and valuation of immovable property collateral.
Banks would also be required to identify whether environmental and social factors are triggers of operational risk losses, EBA said.
"Improving the quality of data on environmental risks is a key priority as most recent data may not yet reflect environmental risks in full...," EBA said.
The watchdog will develop in-house "metrics" to help it supervise environment-related risks at banks.
Banks are already facing a requirement to set out plans on how they will transition to a net zero economy, and these plans should now be reflected in how they tot up risks for calculating capital buffers.
More comprehensive revisions to capital rules to reflect climate risks will be considered for the medium to long term, EBA said. (Reuters)