The report by the High Level Expert Group (HLEG) on Sustainable Finance, released last week and now to be considered by the European Union, gave an inconclusive answer on green capital relief.
The idea, talked up by bankers and Valdis Dombrovskis of the European Commission, involves granting banks lower capital requirements for taking on assets that help the environment.
The HLEG decided to hold fire, for now. While it saw some advantages to the idea, it said: “Evidence of significantly lower risk at the micro-level should also be present.
“At this stage, that is still missing, and existing public proposals for a green supporting factor do not seem to be quantitatively grounded in a risk assessment.”
It also wanted a cap on lower capital requirements to avoid a “green bubble”, and pointed out that banks already enjoy a low capital ratio on mortgages, one of the green assets Dombrovskis highlighted when he said the Commission was “looking positively” at green capital relief.
The same section of the report dealt with the finalised version of Basel III (or Basel IV, as bankers dub it). The latest version of the framework for international banking regulations was agreed in December, but has no legal heft until introduced into regulation by European authorities. On this topic, the HLEG was less restrained in its proposals, albeit more vague.
It relayed banks’ complaints that they have to hold too much capital for project financing, specialised lending and mortgage lending (key areas for green finance). It also wanted smaller banks to be treated more proportionately (i.e. more leniently).
“To avoid harming European banks involved in long term sustainable lending and project finance, the Commission could review the latest and pending changes to the Basel framework, with a particular focus on those banks that are in alignment with the EU’s climate change and [Sustainable Development Goals] commitments,” it said.
While a few confusing paragraphs barely take away from a thorough report, the HLEG comes across as a bit unclear here.
Wanting to fashion Basel regulations around what helps sustainable finance is no different from advocating green capital relief, in the sense that both involve using regulations designed to manage banks’ risk to promote sustainable finance.
Mixing the palette
It is not just the HLEG which is inconsistent in its arguments. Wim Mijs, chief executive of the European Banking Federation, wrote in the Dutch newspaper Het Finanieele Dagblad on January 16 that a brown punishing factor (which would require banks to hold more capital against fossil-fuel-dependent and fossil-fuel-intensive assets) “could negatively impact adequate risk management”.
“Globally speaking there is no clarity about the definition of ‘brown’, while there is a lack of reliable data on the way that ‘brown’ companies affect the climate,” he added.
At the same time, he argued in favour of a green support factor: it “would mean that banks commit less capital for loans that effectively contribute to accelerating the transition to a sustainable, climate-neutral economy”.
But Mijs' arguments apply to both a brown punishing factor and a green support factor. Both factors would promote green lending; but both could hinder risk management.
Reliable data and definitions are lacking for both green and brown assets — although, given how quickly ideas evolve about how best to tackle sustainability challenges, and the difficulty of measuring ultra-new asset classes, this is inevitable.
One suspects the reason Mijs prefers green relief to brown punishment is rather that it lowers aggregate capital requirements instead of raising them. It will also mean banks having fewer awkward conversations with their oil company clients.
While there is a strong case against using bank capital regulations as a tool in the battle to promote sustainable finance, it is still a debate worth having, as the market works out how to green itself.
But some of the arguments put forward in favour appear confused. If the EBF would like to lower banks’ capital regulations in an environmentally friendly way, that is what it should say.
If the EU follows the HLEG’s recommendations and decides it wants to use bank capital rules as a little bit of a spur for certain types of lending associated with sustainability, that is what it should argue for.
This would make for a clearer and more informative discussion.