BIS Quarterly Review Discusses Green Bond Ratings and Bank-NBFI Links
BIS published its Quarterly Review in September 2020. This quarterly review looks at the recovery of financial market from acute stress in March, noting that the upturn has been uneven and corporate balance sheets remain fragile. The review highlights that credit rating outlooks for banks are still generally negative. The concern in the credit default swap (CDS) markets over lower-rated banks underscores the value of a cautious approach to bank capital amid uncertainty about the evolution of the pandemic and the underlying quality of banks’ assets. This issue of quarterly review includes special features that, among others, explore the potential benefits of a firm-level rating system for green bonds and carbon emissions and the vulnerabilities associated with cross-border links between banks and non-bank financial institutions (NBFIs).
The special feature on green bonds highlights the potential benefits of a firm-level rating based on carbon intensity (emissions relative to revenue) to complement the existing project-based green labels. Such a rating system could provide a useful signal to investors and encourage firms to reduce their carbon footprint. Current labels for green bonds do not necessarily signal that issuers have a lower or decreasing carbon intensity, measured as emissions relative to revenue. Such ratings, which could complement the existing labeling systems, can be designed to provide extra incentives for large carbon emitters to help combat climate change. An additional benefit of firm-level ratings is that investors could also use them to rate any financial instruments issued by a firm, including stocks and not only bonds, which only a limited number of companies issue.
The special feature on cross-border links between banks and NBFIs highlights that the financial market turmoil triggered by COVID-19 revealed the growing importance of NBFIs as bank counterparties. The special feature also points out the several vulnerabilities associated with cross-border linkages between banks and NBFIs. While adding to the understanding of the bank-NBFI nexus, the special feature points to important data gaps. Enhancing the available data along four dimensions would help give a fuller picture of financial vulnerabilities and the attendant transmission channels. These dimensions are the domestic exposures between banks and NBFIs, the specific types of NBFIs that banks have as counterparties, the exposures in the NBFI sector, and the financial instruments underpinning all exposures. The sheer size of NBFIs and their growing interconnectedness with banks warrants continued monitoring by authorities. Some NBFIs face a substantially different regulatory environment compared with banks, in addition to no or limited formal access to central bank liquidity or public-sector credit guarantees, all of which only heightens the need for such monitoring.
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Keywords: International, Banking, Securities, Green Bonds, ESG, Climate Change Risk, NBFI, COVID-19, Credit Ratings, Quarterly Review, Cross-Border Banking, BIS
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