The supervision and regulation of climate risks for banks: overview from the perspective of a European practitioner

Abstract

Climate change is one of the most pressing issues of our time, and in the transition to a greener and more environmentally sustainable economy and financial system, banks and their supervisors and regulators play a key role. By giving preference to climate-friendly borrowers and green assets in their financing and investment decisions, banks have a huge leverage over economic actors and financial market participants, and thus can help the transition to a greener economy. At the same time, banks must assess and manage the physical and transition risks that emanate from climate change and impact their clients via various transmission channels, thereby affecting the banks themselves. This risk dimension is the focus of this paper. Based on the euro area perspective it answers from a mainly practical perspective the question whether voluntary action by banks is sufficient, or whether additional regulatory requirements and respective supervisory scrutiny are necessary to cope with climate and environmental risks. Furthermore, the paper assesses whether such regulatory requirements should generally be of a qualitative, or also of a quantitative nature, and also the likelihood that regulators will going forward amend the rulebook to allow supervisors to impose direct capital requirements on banks for climate-related risks.