The Basel Committee for Banking Supervision (BCBS) has published the principles for effective management and supervision of climate-related financial risks to enable banks and their supervisory bodies to ramp up their risk-management practices.

The principles, published on June 15, spell out important parameters that will determine all future regulations and represent one of the most concrete steps taken by the committee after its initial assessment in 2020 and the launch of consultations in 2021.

Summary of the principles released by BCBS

Of the 18 principles released by BCBS, 12 focus on enabling banks to manage climate risk more effectively (see Figure 1) and the remaining 6 on enabling supervisory bodies to monitor the climate risk agenda of banks (see Figure 2).

Climate-risk related banking supervision set to increase significantly across the globe

The BCBS is not the first mover in terms of laying out climate risk-related supervisory principles. Several regulatory bodies including the Prudential Regulation Authority in the UK, the European Central Bank, the Monetary Authority of Singapore and the Hong Kong Monetary Authority have already come out with guidelines that mirror BCBS principles to a certain extent. The Office of the Comptroller of the Currency in the US has also come out with draft guidelines and is in the process of reviewing consultations.

Nevertheless, given the primacy of the BCBS as the leading multilateral regulatory body for banking supervision, we expect a major uptick in regulatory scrutiny, with other national supervisor bodies following suit with their own sets of guidelines in line with BCBS recommendations.

National regulatory bodies are expected to enhance the allocation of resources for supervision of climate risk-related risks, setting the tone for deeper scrutiny of banks’ regulatory submissions, methodology, strategies and reporting. The focus has so far been on Pillar 3 disclosures, but we now expect banking regulators to shift towards integrating climate and environmental risks into their regular supervisory methodology of financial risks, ultimately affecting Pillar 2 capital requirements.

Banks need to sharpen climate risk focus, scale up analytical capabilities

The regulators have called upon banks to invest in measuring, mitigating and reporting climate risk based on their size, complexity and risk profile. Hence, global systemically important banks or large internationally active banks have a lot of ground to cover given the far-reaching consequences of these guidelines.

Some banks have already started incorporating climate risk related criteria into their credit risk assessment and approval process, implementing climate risk training exercises for senior management and analysts alike and tackling data challenges exposed by various climate risk stress testing exercises. However, given the number of aspects these principles cover and BCBS’ clear direction to various national and supra-national supervisory bodies, we feel the work done so far by banks represents the tip of an iceberg.