Jacob Gyntelberg's and Stephane Boivin's interview with Børsen: The European Banking Authority wants banks to align capital requirements with social and climate risks

The European Banking Authority wants banks to align capital requirements with social and climate risks

The EU's single banking supervision will take climate and social risks into account when calculating capital requirements for, among other things, bank loans for Europe’s banks. This is expected to lead to interest rates on loans becoming more dependent on long-term risks in the future

The EU's single banking supervision is proposing that climate and social risks in bank lending should in future be part of the capital requirements for Europe's banks. This is expected to have an impact on the price of loans. 

In future, all banks in Europe will have to adjust the capital they are obliged to hold to grant loans, in relation to the climate and social impact arising from using the money from the loans.

This is the view of the EU's single banking supervision, the European Banking Authority, or EBA.

Thus, it is likely that loans with a negative climate or social impact will become more expensive, while loans with a positive impact may become cheaper for the borrowers.

"This is quite important to us. We are the world’s first supervisory authority to make specific suggestions on how to integrate climate and social risks"

Jacob Gyntelberg, Director, EBA

---

‘EU politicians are concerned about the future, and we are both interested in how climate and social risks can affect the banks, and at the same time how we will ensure that banks will contribute to a more sustainable future,’ says Jacob Gyntelberg, the Director of the Paris-based EBA responsible for risk and economic analysis.

New recommendations for bank risk

Last year, the EBA issued a ‘discussion paper’ on how banks in Europe can address the risks related to climate and social conditions. Now the supervisory authority has issued substantive recommendations which, however, still need to be adjusted and put into practice.

‘The way we see it, environmental and social impacts in relation to banks are not new risks. They are, however, and will continue to be, risk elements that banks need to quantify and address, both when they are considering granting loans, when they are pricing loans, and when they are granting loans,’ says Jacob Gyntelberg.

Specifically, the EBA proposes that banks in Europe should in future quantify the social and climate risk of granting a loan or making an investment, including the banks' own investments in securities.

The three pillars of banking

According to the EBA, it should be part of the banks’ so-called ‘Pillar 1’ requirement, concerning the fundamental capital requirement applicable to all banks, as opposed to ‘Pillar 2’, concerning specific capital requirements for each bank, and ‘Pillar 3’, concerning the banks’ transparency in relation to their business and risks.

‘The European Commission has asked us whether the capital requirement should be lowered for ‘green’ loans, and increased for ‘brown’ loans,’ says Jacob Gyntelberg with reference to the climate profile of loans granted by banks.

‘But we don’t think this is a good idea. Instead, we recommend a risk-based approach where social and climate risks are integrated into the overall risk calculations of European banks,’ he continues.

The Pillar 1 requirement is by far the most difficult one for the banks. Figures from the European Central Bank (ECB) show that if a large bank in the Euro zone grants a loan adjusted for a risk of EUR 1 million, the bank will have to reserve at least EUR 107 000 in equity. Of this, the Pillar 2 requirement amounts to only EUR 11 000, while the rest is the Pillar 1 requirement.

Therefore, even small changes up and down the Pillar 1 requirement can have a large impact on the banks' capital requirements in relation to their lending to customers.

“We need to do better in understanding how climate and social risks relate to credit, market and operational risks"

Stephane Boivin, Head of the ESG Risk Unit at the EU's single banking supervision

Since equity must be remunerated by banks, a higher capital requirement for an oil rig, for example, will usually mean that the banks will demand a significantly higher interest rate or price for granting the loan.

Banks hate the idea

Already in May last year, when the EBA published its discussion paper, the banks’ EU lobbyists, the European Banking Federation (EBF), were strongly critical of the idea of imposing a strict Pillar 1 requirement on banks in relation to climate and social risks.

‘Current models to measure risk are not developed for long time horizons. Planning capital 20 to 30 years into the future is also difficult, since uncertainty increases with accumulated assumptions,’ the EBF said last year.

But the European Banking Authority does not agree with this argument.

‘The problem must be studied from a ground-up perspective and with sufficient data. We believe that banks will need study these risks and measure them systematically. And over time, as data and risk models improve, banks should also find it easier to assess these risks,’ says Jacob Gyntelberg.

Need for a more long-term approach

He admits, however, that banks will need to make a much longer term assessment in future, before granting loans to their clients.

‘In addition to getting better data and understanding of how climate and social risks affect the overall risk of granting loans, banks will also need to adopt a longer time horizon and change the way they look at lending today,’ says Jacob Gyntelberg and continues:

‘Take wind turbines as an example: It's definitely a green investment. But they must also be taken down again, which must be performed sustainably. Therefore, this cost must also be included in the loan models.”

The banks’ lending rates will be affected

The European Banking Authority emphasises that the forthcoming requirements are clearly expected to have an impact on the price, i.e. the interest rate, of loans, depending on their climate and social risk profile.

‘Already today, banks are required to take ESG factors into account when they grant loans, so some environmental risks are already included in the Pillar 1 calculations. But our report emphasises the importance of banks pricing climate and social risks when they grant loans,’ says Stephane Boivin, Head of the EU Banking Authority's ESG Risk Unit.

At the same time, however, he points out that it is too early to make a guess on what the future bank requirements will mean for interest rates on bank lending.

‘We still need to understand the impact on Pillar 1 capital requirement. We need to do better in understanding how climate and social risks relate to credit risks, market risks and operational risks, and how they lead to differences in risk,’ says Stephane Boivin and continues:

‘But this is something we will look into in the coming year, and we have been asked to assess the possibility of creating a methodology to classify banks' exposures based on ESG risks.’

An important milestone

The EBA's Jacob Gyntelberg emphasises that the new recommendations for banks to include climate and social risks in their capital requirements, when granting loans, are only part of a larger package of changed requirements for banks.

‘This is quite important to us. We are the world’s first supervisory authority to make specific proposals on how to integrate climate and social risks into Pillar 1. It shows that these risks are something we are very concerned about in Europe, and this report will also be included in other guidelines, in relation to stress testing of banks and how national supervisory authorities may use their toolbox to ensure that these risks will be properly managed,’ says Jacob Gyntelberg.

The interview as conducted by David Bentow.

Børsen (Denmark)