Lower capital requirements for green lending?
Over the past year, various proposals were discussed to amend the European capital frameworks for banks (CRR/CRD IV) in order to stimulate sustainable finance. One of these included the introduction of a green supporting factor that would lower the capital requirements for green lending. We see the importance of promoting sustainable finance and are actively involved in supporting initiatives in this area, for example through the NGFS. We believe that adjusting the capital buffers is only opportune if there is sufficient evidence that green finance involves lower risks compared to conventional finance. The NGFS is currently researching whether this is the case.
Ensuring well-capitalised banks and a sound financial system are the key objectives of maintaining capital buffers in the first place. The size of capital buffers is risk-based: the higher the risks in a bank's balance sheet, the higher its capital buffer. Introducing a supporting factor for green lending that lowers these buffers would interfere with this principle, since supporting factors are not based on clearly identifiable risk differences. In addition, we support Jan Tinbergen's tradition that a policy instrument must have a single, unambiguous objective in order to be effective. Lowering capital buffers through a green supporting factor could compromise the key objective of maintaining capital buffers, which is to safeguard the system of sound and solvent banks. There is no conclusive evidence as yet that green lending carries less risk or that conventional lending might carry more risk than originally thought. The fact that there is no clear consensus on the exact definition of "green" finance is one of the main reasons for this lack of evidence. In the financial sector as well as in academic research, different definitions are applied. Academic research tends to focus on the risk and returns of investments based on environmental, social and governance (ESG) criteria in general, but research into the specific risks related to green lending is limited. Another hampering factor is the fact that evidence is traditionally gathered from historic data sets that do not adequately reflect the challenges associated with the energy transition and achieving the Paris climate agreement goals. Forward-looking methods such as scenario planning and stress tests could well be more appropriate here. They could be used to recalibrate risk factors, for example by increasing the risk weight for certain categories compared to historical data, and lowering it for other categories, such as green finance. However, recalibrating the risk factors should not automatically lead to lowering the capital requirements, since this could compromise financial stability. The required amount of capital could decrease, however, as loan portfolios evolve over time with higher proportions of finance that carry lower risks and therefore require less capital.
Questioning the effectiveness of supporting factors in capital frameworks
The effectiveness of supporting factors in capital frameworks is being questioned. For example, in its assessment of the effectiveness of the SME supporting factor, the European Banking Authority (EBA) found that it had not resulted in more lending to the SME sector since its introduction in 2014. Likewise, it remains to be seen whether a green supporting factor would actually boost green lending. Rating agencies such as Standard & Poor's and Moody's have expressed their intention to consider the actual risks related to sustainable finance in their projections. Like the financial sector, they are making efforts to improve their estimates. This would make a green supporting factor redundant. Moreover, there are alternatives. Policy instruments specifically created to promote sustainable finance will most likely be more effective. Examples include implementing tax policies (taxes and subsidies) as well as setting binding standards (e.g. real estate energy efficiency standards).