Hidden In Plain Sight: BCBS Discovers Climate Capital And Liquidity Requirements In Existing Rulebook – Financial Services
On December 8, 2022, the Basel Committee on Banking Supervision
(“BCBS”) released guidance to clarify how climate-related
financial risks may be captured in existing capital and liquidity
requirements for banking organizations (“Climate
FAQs”).1 The Climate FAQs are
noteworthy because they indicate that standard setters believe
climate-related financial risks should be included in bank capital
requirements and begin to define specific obligations for banking
organizations.
In this Legal Update, we provide background on BCBS and climate
risk regulation and discuss some of the main points from the
Climate FAQs.
Background
BCBS has promulgated and revised standards for capital and
liquidity requirements for banking organizations for many years,
with the most recent major revisions occurring in 2017.2 BCBS also has addressed aspects of
climate-related financial risk, most notably by issuing principles
for the effective management and supervision of climate-related
financial risks earlier this year.3
However, to date there has been little effort to integrate climate
risk considerations into the prudential requirements for capital
and liquidity, with US Treasury Secretary Janet Yellen stating
earlier this year that it is too early to consider adjusting
capital requirements for US banks based on climate change-related
risks.4
Climate FAQs
The Climate FAQs are styled as 19
questions and answers on the application of existing capital
and liquidity requirements to climate-related financial risks. BCBS
states that the Climate FAQs are intended to clarify the
application of existing requirements to the unique features of
climate-related financial risks and should not be interpreted as
changes to the underlying standards. However, several parts of the
Climate FAQs define compulsory and prescriptive courses of action
for banking organizations and, therefore, arguably do create new
obligations.
For example, the response in FAQ #1 states that banking
organizations “should integrate climate-related financial
risks either in their own credit risk assessment or when performing
due diligence on external ratings.” It is hard to see how that
is anything short of a new regulatory requirement to the credit
underwriting/due diligence process.
Similarly, the response in FAQ #4 states: “When determining
whether a given corporate meets the investment grade definition,
banks should consider and evaluate how material climate-related
financial risks might impact the capacity of the corporate to meet
its financial commitments in a timely manner even under adverse
changes in the economic cycle and business conditions.” In
some jurisdictions, such as the United States, the investment grade
determination is a multi-factor analysis that is designed by each
banking organization within broad guidelines set forth by
regulators. Based on the firm position taken by BCBS in this FAQ,
some banking organizations might consider incorporating a
climate-related financial risk element in their investment grade
determination procedures.
The Climate FAQs also are addressed to national regulators and
suggest specific changes to capital requirements to account for
climate-related financial risks. For example, the responses to FAQ
#6 and FAQ #7 state that national regulators should consider
increasing risk-based capital requirements and expanding appraisal
requirements for real estate exposures to account for
climate-related financial risks.
With respect to liquidity regulation, the response to FAQ #18
indicates that banking organizations should incorporate material
climate-related financial risks in their non-standardized liquidity
stress testing activities. There are similar extensions of the
existing requirements for operational risk and market risk capital
requirements in other FAQs.
Takeaways
The Climate FAQs indicate that BCBS has turned a new corner with
respect to the regulation and mitigation of climate-related
financial risks. Where previous issuances had focused on risk
management practices, the Climate FAQs focus squarely on capital
and liquidity requirements.
Fierce Debate Likely to Follow
This new focus is likely to engender debate in BCBS member
jurisdictions, many of which are contending with the difficult
implementation of the Basel Endgame standards for regulatory
capital requirements. We expect particularly fierce debate in the
United States, where even the risk management and traditional
capital proposals from BCBS have been strongly questioned in recent
months. To date, US banking regulators have said that they are not
currently considering capital and liquidity requirements for
climate risks.5 However, given the
prominent role U.S. banking agencies have in the governance of
BCBS, the Climate FAQs suggest increasing comfort by US regulators
in examining how capital and liquidity requirements could be
modified to incorporate climate risks. We therefore expect the
Climate FAQs to be raised and discussed at congressional oversight
hearings next year.
Useful Starting Point, in the Meantime
From a practical perspective, the Climate FAQs do provide
potentially useful guidance on how to apply the existing capital
and liquidity requirements to climate-related financial risks. To
the extent a banking organization is considering how to enhance its
risk management practices to better incorporate environmental
risks, examining the Climate FAQs is a useful place to start.
Footnotes
1 BCBS, Basel Committee clarifies how climate-related
financial risks may be captured in the existing Basel
Framework (Dec. 8, 2022), https://www.bis.org/press/p221208.htm.
2 BCBS, Governors and Heads of Supervision finalise
Basel III reforms (Dec. 7, 2017).
3 Please see our Legal Update on the BCBS
principles.
4 See Christopher Condon, Janet Yellen Says
Higher Bank Capital Rules for Climate Risk Are
“Premature,” Bloomberg (Feb. 2, 2022), https://www.bloomberg.com/news/articles/2022-02-02/yellen-says-higher-bank-capital-rules-for-climate-premature.
5 See e.g., Testimony by Michael Barr (Nov. 15,
2022) (“The pilot climate scenario analysis exercise . will be
exploratory in nature and not have capital consequences.”);
Federal Reserve, Climate Change and the Role of Regulatory
Capital: A Stylized Framework for Policy Assessment (Oct.
2022) (“Actual implementation entails additional challenges
from several perspectives.”).
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