MNI INTERVIEW: Euro Banks Face Green Capital Add-Ons In Future

Eurozone banks will eventually face higher capital requirements once climate stress tests have been fully incorporated into the supervision framework, but not as a result of the imminent final implementation of Basel III reforms, a European Central Bank representative on the Supervisory Board told MNI.

The results of next year's climate stress tests will not be published or linked to capital requirements, but this should change for future versions of the exercise, Edouard Fernandez-Bollo said in an interview last week, one day after the ECB published its methodology for the tests.

"The objective is that we will progress, and at some time we will be doing that; we will use stress tests for both increasing the capabilities of the bank, and calibrating the capital objectives for stress situations," he said. "At some point, we really aim to incorporate climate risk into the ordinary stress test methodology, and then, of course, it will be published."

Climate considerations would be incorporated into Pillar 2 capital add-ons allocated on a bank-by-bank basis by the supervisor, Fernandez-Boll said.

"The danger would be to get stuck in the present situation, where 80% of banks surveyed say climate risk is very important to them, but 80% of those 80% said, 'We don't have the tools to measure it.' Well, that's a situation that cannot persist."

The supervisor is also about to implement the final section of the Basel III redesign of bank regulation enacted in the wake of the 2007-2008 global financial crisis. Incorporating stricter rules on the use of internal models to calculate risk weights, the new rules have been widely dubbed "Basel IV", but Fernandez-Bollo said they should be manageable for banks even at current profit levels.

"Some banks will be more affected than others, but that's what happens with any regulatory review and there will be a long transition period. And globally, the effect is perfectly manageable even with banks' actual levels of profitability. With the current rate of retained profits, no one will need to raise extra capital," he said.

RISK-SEEKING BEHAVIOUR

But Fernandez-Bollo, who has previously warned over yield-searching behaviour in financial markets, said some banks will face calls for tighter risk-control procedures or higher Pillar 2 requirements.

"We have to be able to tackle what is, I believe, too much risk taking, because banks are looking for yield, be it on traditional credit risk or on market finance, such as leveraged finance," he said.

Having navigated the pandemic, the real challenge for banks and supervisors alike will come once levels of public spending return to a 'new' normal, Fernandez-Bollo said.

"It's clear that the bigger part of the test is not yet there," he said. The real time of reckoning will be manageable, but it will be all the more manageable if banks don't relax now. We are saying to the banks, 'Please don't believe your models that are projecting in the 10 years ahead the three years that they've just seen, because these three years are completely unlikely to be like the 10 years that will be coming.'"

Supervisors too have lessons to be learnt from the pandemic and its aftermath, he said.

"We've had some successes," Fernandez-Bollo said, "but we have some places where we saw it was not very used - for instance, the use of buffers. We have to reflect on that and see how we can make buffers more usable in case of a crisis. We need to take the lessons of that to determine what should be our priorities ahead, because clearly we need now to be sure that the way out is also smooth."

Fernandez-Bollo pushed back against opponents of European Commission proposals that would see supervisors more closely monitor EU-based branches of non-EU banks, arguing that such a move would only bring European banking overseers up to speed with their counterparts elsewhere.

"It is a change from the present standard, but I will not say that it will be a complication, it will be a normalisation," he said.