European banks should integrate environmental, social, and governance risks in their regular risk management framework, the European Banking Authority (EBA) said this week in draft guidelines on the management of ESG risks.
The European authority published a consultation paper on its draft proposals for banks as it launched a public consultation that will run until April 18, 2024.
According to the EBA, climate change, environmental degradation, social issues, and other ESG factors pose “considerable challenges for the economy that impact the financial sector.”
“The risk profile and business model of institutions may be affected by ESG risks, in particular environmental risks through transition and physical risk drivers,” the authority noted.
The management of ESG risks is still at early stages and a “work in progress” in most EU institutions, the banking authority said in the paper.
Despite the fact that some institutions have taken action in recent years, “several shortcomings have been observed in the inclusion of ESG risks in business strategies and risk management frameworks that may pose challenges to the safety and soundness” of banks, the authority added.
However, the EBA noted that while the ESG risk guidelines call for more planning and including ESG factors in risk management, “It is also important to bear in mind that the goal of prudential plans is not to force institutions to exit or divest from carbon intensive sectors.”
Banks across Europe may have to include environmental and social risks in their capital requirements and risk management under new recommendations by the EBA published at the end of last year.
“Environmental and social risks are changing the risk profile for the banking sector and are expected to become more prominent over time,” the authority said in a report in October.
Among other things, the EBA is proposing to require institutions to identify whether environmental and social factors constitute triggers of operational risk losses.
By Charles Kennedy for Oilprice.com
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Charles is a writer for Oilprice.com