Faced with the unprecedented impact of ESG risk on the banking sector, the EBA proposes a new sustainable finance roadmap to be deployed over the next three years. The latter, more exhaustive, is in line with the previous one, almost finalized and covers eight main axes including financial transparency, prudential treatment pillar 1, pillar 2 and pillar 3, stress tests, greenwashing…

1.  The impact of esg on banking risks requires a specific and comprehensive framework

Climate change, environmental degradation, social issues and other ESG factors pose considerable challenges to the global and EU economies. The impact of acute and chronic physical events, the necessary transition to a low-carbon, the seek for a more resource-efficient and sustainable economy, and a more inclusive society, as well as other ESG challenges, are driving and will continue to drive profound economic transformations that will impact the financial sector.

Environmental risks, including climate-related risks in particular, are expected to become more important in the future due to transition factors and physical risk factors.

This can affect all the traditional categories of financial risks to which institutions are exposed. Besides social factors – such as human rights, health or working conditions – and governance factors – such as executive leadership or bribery and corruption – have monetary repercussions on the real economy  on the financial sector.

Overall, ESG risks are changing the risk landscape for the financial sector, including the banking sector, calling for strong action by all stakeholders.

2.  The EBA’s approach to developing its roadmap on sustainable finance

The EBA published its roadmap on sustainable finance and ESG on 13 December 2022. This one:

  • Describes the objectives and timetable for the implementation of mandates and tasks in the field of sustainable finance and ESG risks.
  • Explains EBA’s sequential and comprehensive approach over the next three years to integrate ESG risk considerations into the banking framework
  • Supports the EU’s efforts to make the transition to a more sustainable economy.
  • Contributes to the stability, resilience and proper functioning of the financial system.
  • Builds on and replaces the first EBA action plan on sustainable finance published in December 2019.
  • Covers mainly the three pillars of the banking framework (market discipline, supervision, prudential requirements), as well as other related areas and risk monitoring and assessment.
  • Ensures continuity of the actions undertaken in the previous action plan, while taking into account the necessary adjustments in line with market and regulatory developments, including new mandates and new areas of interest.

3.  The key role of financial institutions in supporting the transition to a more sustainable economy

Financial institutions have a key role to play in managing risks and raising funds for sustainable projects, given their unique position in intermediating capital flows through their lending, investment and advisory roles. Banks also have the technical expertise essential to assess the risks and opportunities associated with sustainable assets, particularly during this transition.

4.  A first EBA roadmap for sustainable finance in 2019 almost finalized

The EBA’s first action plan on sustainable finance published in 2019 specified the following areas of focus:

  • Strategy and risk management.
  • Key indicators and publication.
  • Stress testing and scenario analysis.
  • Supervisory treatment.

EBAinitiatives in these areas focused on:

  • Understanding market practices related to ESG aspects.
  • Review of existing regulatory concepts from an ESG perspective.
  • The formulation of common definitions and terminology applicable in the regulatory framework.
  • Providing initial guidance on specific aspects, in line with the sequential approach.

Although many of the actions envisaged under the 2019 Action Plan have already been finalised, work in these areas will continue, also following the sequencing previously specified.

5.  A second and wider EBA roadmap for sustainable finance in  2022 with 8  working areas

The EBA’s activities on ESG risks and sustainable finance can be classified into the following main areas

5.1.   Transparency and publication of information

In the area of transparency and disclosure, EBA will continue its work related to the development and implementation of institutions’ ESG risks and broader sustainability disclosures. Indeed, promoting transparency and market discipline on ESG issues through enhanced disclosure (i.e. Pillar 3 and other sustainability-related reporting requirements) has been and will continue to be a key priority for EBA.

5.2.   Risk management and supervision (including transition plans)

EBA will continue its efforts to ensure that ESG factors and risks are properly integrated into institutions’ risk management frameworks and supervision, including through further developments on climate stress testing. In order to maintain a safe and resilient banking sector, there is an urgent need to ensure robust ESG risk management by institutions through a harmonised set of rules at EU level.

5.3.   The supervisory treatment of exposures

In the area of prudential regulation, EBA has initiated an assessment of whether changes to the current prudential treatment of exposures to incorporate environmental and social considerations would be justified.  EBA will continue this work in the future.

5.4.   Stress tests

In turn, institutions’ ESG risk practices and exposures will need to be progressively assessed and monitored by competent authorities under Pillar 2, including through further developments in climate stress testing. Thus, stress testing and scenario analysis will remain a particularly important tool in the years to come.

5.5.   Standards and labels

EBA will contribute to the development of greens standard and labels. Indeed, as the sustainable finance market develops, further work is needed to determine the relevance and content of additional ESG standards or labels.

5.6.   Greenwashing

EBA will contribute to the development of measures to address emerging risks in this area, such as green money laundering.

5.7.    Prudential reports

EBA will assess the basis of the expected supervisory reports to ensure that they allow for proper monitoring of ESG risks.

5.8.   ESG and sustainable finance risk monitoring framework

Taking into account the evolution of data and indicators, ESG risks and developments in sustainable finance will need to be assessed and monitored on an ongoing basis.

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6.  References