European Banking Authority Publishes Discussion Paper on Role of Environmental Risks in the Prudential Framework

The European Banking Authority has published a discussion paper on whether, and how, environmental risks should be incorporated into the EU prudential frameworks for EU credit institutions and investment firms. The feedback received will help the EBA to determine (in accordance with its mandates under the EU Capital Requirements Regulation and EU Investment Firm Regulation) whether the EU should introduce specific prudential treatment for certain exposures and assets that are substantially linked to environmental and/or social objectives and impacts. Responses should be submitted by August 2, 2022.

Environmental risks are a real and growing problem for the global financial sector. The current EU prudential framework consists primarily of the EU Capital Requirements Regulation and Directive, which govern credit institutions, and the EU Investment Firm Regulation and Directive, which govern investment firms. The prudential regimes impose rules upon those firms to manage risks to the financial stability of the EU. The discussion paper considers different aspects of the prudential framework (namely provisions covering credit risk, market risk, operational risk and concentration risk), as well as the EU IFR, and how each interact with environmental risks. It seeks input from respondents on a variety of questions, including measures that respondents may have already adopted to deal with environmental risks and any potential changes that should be made to existing or upcoming prudential frameworks.

The EBA's provisional conclusion is that the existing bank prudential framework is capable, to some extent, of accommodating environmental risk and could be enhanced with targeted adjustments. Forward-looking methodologies may also be incorporated into the framework to enhance its ability to deal with environmental risks, which are also forward-looking.

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