Banks: what impact will sustainable finance regulations have on profitability, adjusted for environmental risks?

11/05/2023 | RSE

To highlight this issue, KYC Consulting offers its analysis ⬇️

The E&S theme continues to make its mark on the banking environment. This is an opportunity to review the regulatory and supervisory authorities’ increased pressure on banking institutions since the end of 2022. Three new requirements now govern the consideration of environmental risks by banks.

On november 2, 2022 the ECB published the result of its thematic review on environmental and climate-related risks.

This thematic review was aimed at both large and small institutions. It aimed to help align the banking sector with its supervisory expectations, as set out by the ECB in its guide on climate and environmental risks (“the guide”) published in November 2020, and updated in January 2022.

Accordingly, the ECB has set an individual timetable for each entity subject to prudential supervision to meet, by the end of 2024, the climate-related expectations set forth in its “Guide”. The ECB expects banks:

1. As a first step, to adequately categorize climate and environmental risks and conduct a full assessment of their impact on banks’ activities by the end of March 2023.

2. Secondly, by the end of 2023 at the latest, they integrate climate and environmental risks into their governance, strategy and risk management.

3. Finally, by the end of 2024, that they meet all remaining prudential expectations for climate and environmental risks identified in 2020, including full integration into the internal capital adequacy assessment process and stress tests. 

In parallel to the ECB, the EBA (European Banking Authority) presented at the end of 2022 its roadmap in the area of sustainable finance and environmental, social and governance (ESG) risks. This explains the EBA’s sequential and comprehensive approach over the next three years to integrate ESG risks into the banking framework and support the EU’s efforts to achieve the transition to a more sustainable economy.

According to the Implementing Regulation (EU – 2022/2453), large banking institutions must disclose information on environmental, social and governance risks under Pillar 3 of the Capital Requirements Regulation (CRR) from the first half of 2023. At the beginning of April 2023, several large banks had already published them. This reporting responds to specific requests for both qualitative and quantitative information.

The implementation of these requirements heralds numerous and profound transformations within banks, which will have to integrate these ESG criteria into their operations and report on them.

This increasingly demanding approach must be integrated with the demands for cost reduction that have dominated the banking sector for several years.

It is difficult not to consider the management of the climate emergency by banks as an additional cost of compliance imposed by regulators – with potentially increasing precision and expectations moving forwards – as a way to contribute to reducing greenhouse gas emissions.

Nevertheless, the regulation of sustainable finance is also an incentive to take advantage of opportunities to develop new products (e.g., supporting clients in the transition to a low-carbon economy) and to control the climate transition riks (risks resulting from relative uncertainly created by the global shift towards a more sustainable, net-zero economy), which could accentuate credit risk in particular, while offering the possibility of developing business opportunities.

However, it is still too early today to see an assessment of the net marginal profitability adjusted for environmental risks (new NBI – costs / risk reduction) resulting from the application of sustainable finance regulations for banks.

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