Europe’s banks need to stop complaining that a new environmental, social, and governance (ESG) rule will make them “look bad” and accept that they will need to start reporting additional data in a few months, European Banking Authority (EBA) chairman Jose Manuel Campa said.

The metric in question is the green asset ratio (GAR), with mandatory disclosure set to kick in from January. Supported by the European Central Bank and lambasted by the finance industry, the ratio reflects the share of a bank’s balance sheet that aligns with the European Union’s (EU) list of sustainable business activities. 

The banks are concerned the ratios are going be too low, and that they are going to look bad because they are too low, said Campa in an interview at the EBA’s Paris headquarters. “But what’s the alternative? Don’t do anything, don’t report anything until I know the perfect figure?” 

A handful of banks have already started reporting. Earlier this month, DNB of Norway said its 2022 ratio was in the range of 6 per cent to 7 per cent – in other words, a maximum of 7 per cent of the lending it does goes towards green businesses. Preliminary figures suggest GAR is likely to be a single digit for most banks for a variety of reasons, including the recurring data problems that characterise ESG disclosures. 

Still, the figures are likely to alarm sustainable investors already concerned that the industry is too exposed to fossil fuel clients. This comes as a number of pension funds have made clear that they are monitoring banks’ loan books with a view to potential divestments, unless financed emissions come down rapidly.

Campa acknowledged that the first impression that bank stakeholders will get of the green asset ratios they see will be incomplete. 

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There will be “all kinds of qualifiers that the banks can put into it about what they measure, what they don’t measure, how they measure it”, he said. The exercise is necessary, however, because “it will trigger actions to get better information”.

Under pressure from investors and supervisors, EU banks are trying to get a handle on the risks to their operations from environmental and social challenges and to highlight their initiatives addressing climate change. Regulators want the industry to understand that there is little patience for foot-dragging, as ESG gets embedded throughout the EU’s framework of financial rules. 

The pace and scope of changes have led to pushback, and Campa noted that the EBA routinely hears the complaint that “there’s a little bit of a sense of chaos or lack of organisation, lack of coordination”. But there is no magic wand to fix everything at once, he said.

Among pressing questions is the extent to which banks have enough capital to absorb potential losses triggered by climate change in the years ahead, or whether the current system for setting minimum requirements needs to be updated. 

The EBA, which is close to releasing a report on environmental risks and how these might be reflected in industry-wide capital requirements (known as Pillar 1), has concluded that the old playbook of looking to historical losses no longer works.

“We need to think differently about the methods that we have to assess this risk,” Campa said. “And as a regulatory community, we have to be more open-minded about the fact that we need to confront this challenge.”

To address that, the EBA will be providing guidelines “on how we think that supervisors and firms and banks can do a stress test on climate-related things, to try to help them model that”, Campa said.

Banks meanwhile have pushed for lower capital requirements for investments in companies that address climate change, as an incentive to take the risks associated with new technologies. An alternative suggestion has been higher capital requirements for exposures to heavy emitters. 

Campa said the problem of a so-called green supporting factor is that it may leave banks without the capital they need to survive losses. What is more, a heavy-emitter requirement may incorrectly penalise banks if risks already have been incorporated into valuations, for example by a poor rating from a credit-rating company. 

In the best cases, you are making mistakes, and, in the worst, banks go bust, said Campa. “When we are asked about the green supporting factor, we are reluctant because that’s climate policy.”

That, Campa said, is best done with policies that address the real economy. “The financial sector then should assess the risks, facilitate the financing that goes to those climate policies.” BLOOMBERG