Capital adequacy in banks and sustainable finance: the Green Supporting Factor

Abstract

Starting from the analysis of the contents of the EU Action Plan on Sustainable Finance, we focus on action eight: “The EU Commission will explore the feasibility of including risks associated with climate and other environmental factors in institutions’ risk management policies, as well as the potential calibration of capital requirements of banks as part of the Capital Requirement Regulation and Directive. The aim would be to consider such factors, where this is justified from a risk perspective, to safeguard the coherence and effectiveness of the prudential framework and financial stability. Any recalibration of capital requirements, based on data and the assessment of the prudential risk of banks’ exposure, would need to rely on and be coherent with the future EU taxonomy on sustainable activities”. We focus on the characteristics of the Green Supporting Factor (GSF), a particular weighting mechanism for bank loans, useful to integrate environmental sustainability in the risk assessment and in the prudential requirements of banks. In light of the study carried out, we argue that it is possible to introduce corrective systems that favor green loans or penalize brown loans towards the ecological transition. Furthermore, to check the actual effectiveness, in particular of the GSF, and to correctly calibrate its extent following an assessment of ESG risks (significantly climate risks), we review two experimental applications carried out by financial intermediaries.

Keywords

• green supporting factor; capital adequacy