Environmental and social risks in the prudential framework

The European Banking Authority (EBA) published a Discussion Paper (DP) in 2022, which initiated the analysis of the adequacy of the current Pillar 1 framework to address environmental risks. In this context and taking this DP as a starting point, the EBA has published a Report on the role of environmental and social risks in the prudential framework.

Integration of environmental and social risks in the prudential framework

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Executive summary

The Report on the role of environmental and social risks in the prudential framework sets out short, medium and long-term actions to integrate these factors in the calculation of credit, market, operational, liquidity and concentration risk, as well as recommendations for the institutions themselves. Some of these recommendations affect the calculation of capital buffers, while others imply changes in the regulatory framework for investment firms.

Main Content

This technical note aims to summarise the most salient aspects of the EBA recommendations:

• Credit risk. For the standardised approach, competent authorities should, in the short term, verify that due diligence requirements include environmental aspects. In the medium to long term, the EBA will, among other things, monitor the progressive integration of environmental factors into the value of financial collateral. Into the context of the internal ratings-based approach, environmental and social factors should in the short term be integrated into credit rating, rating assignment, risk quantification (e.g., through the margin of conservatism (MoC), downturn component, calibration segments) and their implementation (e.g., through expert judgement and overrides).
• Market risk. In the short term, institutions should consider environmental risks in relation to trading book risk appetite, internal trading limits and new product approvals.
• Operational risk. Institutions should determine in the short term whether environmental and social factors are operational risk loss triggers.
• Liquidity risk. The EBA does not recommend changes to the calculation of the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).
• Concentration risk. In the short-term, the EBA will develop exposure-based metrics for measuring environment-related concentration risks and, in the medium to long term, will assess the introduction of Pillar I, thresholds and capital buffers.
• Capital buffers. In the short term, the EBA will assess the need to amend its guidance on the appropriate subsets of sectoral exposures to which a systemic risk buffer (SyRB) may be applied, while in the medium term it will evaluate the most appropriate measures to address environmental risks, in coordination with other initiatives.
• Investment firms. The EBA recommends that the treatment of environmental and social risks for investment firms remains within Pillar 2 for all K factors, including those related to client risk (RtC).

Download the technical note on Environmental and social risks in the prudential framework.