In its response to the consultation by the Basel Committee on Banking Supervision (BCBS) on the revision of the “core principles”, Finance Watch calls supervisors to take the specificity of climate risk into account by expanding their time horizon of consideration and by focussing on the system-wide macroprudential view on the risk.
Finance Watch welcomes the revision of the Core principles for effective banking supervision (“Core Principles”).
Given that the Core Principles constitute a global standard for the sound prudential regulation and supervision of the banks and serve as baseline for the national rule of BCBS members and beyond, it is essential that these Principles keep pace with the developments of the financial system and supervisory practices, in particular adequately reflect new and emerging risks, as well the growing complexity of the financial system as such.
Moreover, incorporating climate-related financial risks into the Core Principles is an important step in bringing these risk considerations into the bank prudential framework holistically – following the publication of the stand-alone BCBS Principles for the effective management and supervision of climate-related financial risks in 2022. In particular, we would like to focus our response on climate-related financial risks in relation to bank risk management practices, supervision and macroprudential aspects.
When considering the revised Core Principles, we emphasise the need to evolve risk management and supervisory practices in response to the specific and in the meantime widely-recognised features of climate-related financial risks such as: i) their forward-looking nature where historical data is not useful in deciding on prudential actions due to the unprecedented developments of physical climate risk, on the one hand, and no precedents of transition in the past, on the other hand; ii) path-dependency of climate developments and endogeneity of financial sector actions, i.e. its actions today determine the level of risk in the system in the future iii) unpredictable and partially longer-time horizons of climate risk materialisation; iv) inherent uncertainty in climate science and the pace of climate change, non-linearity and irreversibility of climate developments, presence of tipping points; v) a high degree of complexity of economic impacts of climate change, which are not limited to direct physical damage and transition effects, but also include broader socio-economic impacts such as loss of economic activity/GDP in multiple sectors, mass migrations, loss of labour productivity etc. And finally and probably most importantly, the most disruptive climate-related events represent radical uncertainty rather than risk, which requires a completely different approach when dealing with it compared to other risk types financial institutions are dealing with.
All this means that precautionary principle should guide supervisory and risk management actions on climate risk. Supervisors should crucially expand their time horizon of consideration and focus on the system-wide macroprudential view on the risk. For this, the double materiality perspective is crucial from the supervisory perspective, as given the existing design of the prudential framework, individual financial institutions are not in the position to account for the externalities/impacts of their individual actions on the level of systemic risk.
Comments on specific core principles
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