09 May 2022

EBF: Pillar 1 capital charge for climate risk: Wrong tool for the right purpose

Two years ago, governments, supervisors and regulators pleaded banks to use their capital, reducing the ratios, in order to keep on financing the economy after the outbreak of the pandemic.

We learnt some lessons:

• The prudential status of the banking system is solid enough to withstand a major unexpected shock.
• However, the EU regulatory framework is too rigid. Too much weight has been put on Pillar 1 measures. So much, that authorities were trapped when their intervention was necessary.
• As a consequence, a regulatory quick fix had to be promptly enacted in order to ease off Pillar 1 measures and let banks play their role as part of the solution.
• Since then, global standard setters, central bankers, prudential regulators and academics, are discussing about how to make the prudential framework more flexible without detriment to its level of confidence. Flexibility means less hardwired regulation and more manageable and targeted prudential tools.

Climate change will bring about new risk considerations. The prudential framework offers multiple tools to tackle them progressively. Some argue that hardwired Pillar 1 capital increases by means of risk-weighted adjustment factors should be imposed. The lesson of the pandemic taught us that Pillar 1 is not the right measure at this point. It would make the regulation more rigid but not more robust.

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