The Basel Committee on Banking Supervision (BCBS) issued responses to frequently asked questions (FAQs) to clarify the way in which climate-related financial risks may be captured in the existing Pillar 1 standards of the Basel framework. Additionally, the Bank for International Settlements (BIS) published a paper that examines practices on the pricing of climate risks in financial markets.
The paper on climate risk pricing notes that physical and transition risks related to climate change are starting to be priced, though concerns are growing that current prices do not fully reflect the risks. The paper also notes that investors grapple with three major challenges when seeking to price climate risks adequately. First challenge is that the aggregate nature of climate risks limits the availability of risk-sharing arrangements and hedging instruments while the second challenge is around the high degree of uncertainty about climate risks and concrete policy actions to address them, which heightens modeling and measurement challenges. The third challenge is that the information available to investors about climate risks and their consequences is often incomplete or imperfect. Furthermore, investors seeking to extract information from environmental, social, and governance (ESG) ratings often face uncertainty about a true ESG profile of a firm. ESG rating providers appear to give a higher weight to the existence of corporate policies rather than forward-looking climate metrics such as reductions in greenhouse gas emissions and intensity. Thus, it becomes important to have effective tracking and verification processes to ensure that relevant information has been adequately incorporated into prices, so that market participants can verify and assess progress in line with a low-carbon transition and align company objectives with actions to mitigate climate risks.
The clarifications on the inclusion of climate risks in Basel framework cover aspects such as calculation of risk-weighted assets for credit, market, and operational risks, stress testing, and calculation of liquidity coverage ratio. The document intends to facilitate a globally consistent interpretation of the existing Pillar 1 standards, given the unique features of climate-related financial risks and should not be interpreted as changes to the standards. The responses to FAQs are consistent with the Principles for the effective management and supervision of climate-related financial risk, which the Basel Committee published in June 2022. With this, BCBS is examining the extent to which climate-related financial risks can be addressed within the Basel Framework, identifying potential gaps in the current framework, and considering possible measures to address these gaps. The current publication represents a set of responses to initial FAQs but should not be considered an exhaustive list of standards where the impact of climate risk drivers should be considered. BCBS will publish additional FAQs in future, as needed, to facilitate implementation of the existing Basel Framework, particularly as the availability of sufficiently granular data and consistent measurement methodologies for climate-related financial risks improves over time.
Keywords: International, Banking, ESG, Climate Change Risk, Basel, Pillar 2, FAQ, Credit Risk, Regulatory Capital, Physical Risk, Transition Risk, Sustainable Finance, ESG Ratings, BCBS, BIS
Previous ArticleMAS Consults on Framework for Stablecoin-Related Activities
The European Banking Authority (EBA) has published the final templates, and the associated guidance, for collecting climate-related data for the one-off Fit-for-55 climate risk scenario analysis.
The European Banking Authority (EBA) recently published a report that recommends enhancements to the Pillar 1 framework, under the prudential rules, to capture environmental and social risks.
As a follow on from its prudential standard on the treatment of crypto-asset exposures, the Basel Committee on Banking Supervision (BCBS) proposed disclosure requirements for crypto-asset exposures of banks.
The Basel Committee on Banking Supervision (BCBS) and the European Banking Authority (EBA) have published results of the Basel III monitoring exercise.
The Prudential Regulation Authority (PRA) recently issued a few regulatory updates for banks, with the updated Basel implementation timelines being the key among them.
The U.S. Department of the Treasury has recently set out the principles for net-zero financing and investment.
The European Commission (EC) launched a stakeholder survey on the draft International Guiding Principles for organizations developing advanced artificial intelligence (AI) systems.
The finalization of the two sustainability disclosure standards—IFRS S1 and IFRS S2—is expected to be a significant step forward in the harmonization of sustainability disclosures worldwide.
Decentralized finance (DeFi) is expected to increase in prominence, finding traction in use cases such as lending, trading, and investing, without the intermediation of traditional financial institutions.
The Basel Committee on Banking Supervision (BCBS) published reports that assessed the overall implementation of the net stable funding ratio (NSFR) and the large exposures rules in the U.S.