The European Banking Authority Introduces ESG Requirements in Capital Framework

In a pioneering move, the European Banking Authority (EBA) is reshaping the capital requirements framework for European banks to include environmental and social risks in mandatory industry-wide buffers. EBA Chairman Jose Manuel Campa stated that certain short-term adjustments to minimum requirements (Pillar 1) can be implemented immediately, with others phased in gradually and some necessitating new legislation. The EBA’s report, released on Thursday, underscores the increasing threat to financial stability posed by Environmental, Social, and Governance (ESG) factors such as climate change and inequality.

The new ESG requirements represent a significant shift, with a focus on integrating ESG risks into collateral values, trading book risk budgets, and credit assessments. Banks are urged to adapt internal models to incorporate environmental and social factors and limit the use of overrides. The EBA emphasised the importance of forward-looking approaches, emphasising the need for collaboration between banks and regulators. While acknowledging the complexity, Campa highlighted the urgency of addressing correlated risks arising from climate change, indicating a vital paradigm shift in risk management strategies. These changes align with the EU’s broader initiative, showcasing its proactive response to climate change risks and setting a global benchmark for banking sector adaptation to ESG challenges.