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Responsible banking 02 Oct 2019

Financial regulation to address the climate emergency

After last week’s climate summit in New York, there is still a lot of uncertainty around the feasibility of fulfilling either the 2030 Sustainable Development Agenda goals or hitting the 2050 carbon neutrality target. In an article written by BBVA Research’s Arturo Fraile, the economist warns that “time is running out, and progress must be made” because positive results are still on the distant horizon. In his opinion, financial regulation and supervision will be key to this unavoidable transition.

From the author’s perspective, there are at least three essential conditions that are required if we are to fulfill these goals “causing neither disruption nor undesired consequences to the financial system or the real economy.”

First, “a framework that enables an orderly and credible transition” is needed. Second, a flexible approach that weighs different scenarios in different countries and the rate at which they can respond is also required. It needs to take into account different requirements for emerging and developed countries, according to their ability to live up to their commitments. And finally, the BBVA Research economist stresses the importance of using value-adding data to “measure, analyze, and manage the financial risks associated with climate change and other environmental, social, and governance (ESG) issues.” Along this line, he asserts “prices of financial assets must be priced to adequately reflect these risks so that stakeholders can make appropriate capital allocation decisions.”

Fraile also points out different regulatory developments — currently voluntary — that will become mandatory. He summarizes some of the steps involved, such as those taken by the Central Banks and Supervisors Network for Greening the Financial System and the European Banking Authority, both of which have already published plans “to sequentially integrate climate change as a source of financial risk,” an action that will impact minimum capital requirements. Furthermore, “The European Central Bank included climate-related risks for the first time in its banking supervision risk assessment for 2019 and has publicly announced the possibility of incorporating those risks in future stress tests.”

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