At this stage, should regulatory Pillar 1 capital requirements be increased to reflect climate risk of certain assets?
The fifth debate of the #FBFDiscuss will develop around the question whether at this stage should regulatory Pillar 1 capital requirements should be increased to reflect climate risk of certain assets?
Financial institutions can play a key role in mitigating the effects of climate change and supporting the transition to a low-carbon economy. There has been extensive discussion on which prudential instruments would be most effective in equipping banks with better tools to manage climate risks and contribute to the green transition. One of the most contentious issues relates to the incorporation of climate-related financial risks into Pillar 1.
Back in 2017, the European Commission declared its interest in reducing capital requirements for projects and investments classified as green by introducing a Green Supporting Factor (GSF) to lower bank’s capital requirements to incentivize green lending and climate-friendly investments. This sparked a huge debate, and since then, discussions have focused mainly on issues related to the level of risks that green or brown activities may entail and how to effectively measure and define assets’ risk profiles, as well as on the actual effectiveness of Green or Brown adjusting factors, among others. But, which are the best tools to benefit climate-friendly activities while discouraging funding for carbon-intensive industries? What are the most effective ways in which financial institutions can contribute to the low carbon transition and cope with climate-related risks? Should capital requirements be used as a policy tool to encourage green and sustainable investments, or should they follow a risk-based approach?