The EBA proposes improvements to the Pillar 1 framework, aiming to incorporate environmental and social risks

Recognizing the transformative impact of environmental and social risks on the banking sector's risk profile, the report anticipates their increasing prominence over time. They affect traditional categories of financial risks, such as credit, market and operational risks. Consequently, they pose challenges not only to individual institutions but also to the overall financial stability of the system.

The report recommends risk-based improvements to the Pillar 1 framework, exploring considerations on the potential use of macroprudential tools. Notably, the EBA currently opts against the immediate introduction of a green supporting factor or brown penalizing factors, citing complexities in design, calibration, and potential interactions with the existing Pillar 1 framework.

In the short term, the EBA proposes actionable steps over the next three years as part of the implementation of the revised Capital Requirements Regulation and Capital Requirements Directive (CRR3/CRD6).

These include:

• incorporating environmental risks into stress testing programs,
• encouraging the integration of environmental and social factors in external credit assessments by Credit Rating Agencies
• encouraging the inclusion of environmental and social factors as part of due diligence requirements and valuation of immovable property collateral
• requiring institutions to identify whether environmental and social factors constitute triggers of operational risk losses and the progressive development of environment-related concentration risk metrics in supervisory reporting.

Taking a medium-to-long-term perspective, the report outlines potential revisions to the Pillar 1 framework to better address the growing significance of environmental and social risks. These include considering scenario analysis to enhance forward-looking elements, incorporating transition plans into risk-based enhancements, reassessing the supervisory formula for credit risk, and introducing environment-related concentration risk metrics under the Pillar 1 framework.

Parallel to these prudential initiatives, the EBA commits to reinforce the integration of environmental and social risks across all regulatory framework pillars. This holistic approach underscores the EBA's commitment to fostering a sustainable financial ecosystem.