Dorota Siwek's interview with O Jornal Económico: Sustainability creates opportunities for banks

Sustainability creates opportunities for banks

Dorota Siwek is Head of the ESG Risks Unit at the European Banking Authority (EBA) and will be the keynote speaker at this year’s Fórum Banca, which the Jornal Económico and PwC are promoting on 13 May (see preceding page). In this interview, she talks about the discussion paper released by the EBA last Monday, which explores how banks’ prudential framework should address climate risks. She also discusses the decisive role that banks will play in the future as enablers of a more sustainable economy, given that companies with better sustainability practices will have more favourable conditions for bank financing than companies that pollute more or are less socially responsible.

I would like to start by asking you about the key points in this document published by the EBA last Monday. Why publish this paper now?

The paper itself is quite technical, but the idea behind it is actually quite simple. We are analysing environmental risks and we have noticed that these risks have been increasing in recent years. This trend is also expected to continue in the coming years. There are several policy decisions being implemented in this area, so these are the things that are reshaping the economy. They are also reshaping society, and reshaping the environment in which companies do business. In turn, they also affecting banks through their customers and their commercial operations, because of changes in the risks that banks face. So when we talk about climate risk in a banking context, we see it as a risk driver for the traditional financial risks we always talk about in a banking context. That’s why, in this document, we also look at credit risk, market risk and operational risk. Those are the biggest and most significant traditional financial risks for banks, but banks are also affected by changes in the environment, by environmental policy initiatives, and so on. These trends are raising the question of whether the banks’ prudential framework is ready to handle this, to accommodate these new risk drivers.

I think it may also be important to understand that, typically, the prudential framework is designed to accommodate risks. But that the framework usually addresses risks whose changes fluctuate over the economic cycle. The novelty here, with climate risk, is that the risks do not follow this cyclical pattern. And that’s why questions arise around whether the prudential framework is ready to accommodate these changes. This was why the Commission gave the EBA the task of examining the prudential framework and assessing the extent to which it is ready to accommodate, and if necessary incorporate, some specific prudential treatment for exposures associated with environmental risks or subject to environmental risks. So that’s what we do in this discussion paper. This is just the first step, which aims to collect feedback with opinions from several stakeholders. The responses we receive to this discussion paper, together with other information sources, will help us to prepare the final report, which we plan to publish next year. In the final document, we will also try to include some specific recommendations on whether and how the prudential framework can be adapted to the new situation.

The first climate stress test will take place this year, but only a few banks will need to test for the most adverse scenario. By 2024, all banks supervised by the European Central Bank (ECB) will probably have to perform these exercises. This means that banks have around 2 years to implement these plans and to take climate risks into account in their activity...

The implementation will be gradual. The first set of information will be available next year, based on data from late 2022. However, there will be a phased implementation, so in the next few years the scope of information to be disclosed will be broader.

Is the goal for the financial sector to have a genuine impact on sustainability targets in the different sectors of the economy, since companies that are more sustainable will have better financing conditions?

That’s right. I think there are banks here that are very well positioned to do that, because they have already established those relationships with their customers. That creates a very good opportunity for dialogue between the bank and its customers about their transition plans from the companies’ perspective, about developing those plans in a viable and reliable way – something banks can help with thanks to their experience. And, of course, in doing so they also guarantee the financing of these plans on the bank side. That dialogue between banks and customers really is very important.

In other words, the idea is not for the banks to close off credit to those customers, but instead to help them make the transition towards becoming more environmentally and socially sustainable?

Precisely. That is exactly it.

Are European banks ready for this challenge?

I can tell you that European banks are definitely analysing these topics and the practices of identifying and managing these risks. They are evolving and we can see progress in the availability of data for better identifying and assessing these types of risks, but we are also seeing the development of tools in risk management methodologies. So obviously that’s something that’s still in progress. But I think it’s fair to say that banks aren’t sitting around waiting. They’re already taking action to get ready, and to take these risks into account in their strategies. I also think that it may be worth mentioning here that, from our perspective as regulators, we tend to look at risks. It’s our role to ensure that financial stability is maintained and that banks stay resilient to risks, but it’s clear that these environmental and economic shifts are creating risks for banks, but also opportunities. We don’t really need to point this out to banks, because they already understand it perfectly well. It is also creating new business opportunities, which they are exploring. We see this, for example, when they develop a series of products around sustainability that are specifically designed to finance the transition to a sustainable economy.

How can we avoid a situation in which there is a kind of ‘premier league’ of banks that meet ESG criteria, and a junior league of banks that are a little behind in this area? And what about fintech? How can we ensure there’s a level playing field?

I think this is an area where we need to strike the right balance. On the one hand, it’s important to remember that although the EBA does provide guidelines to supervisors, it is not itself a supervisor. As regulator, the EBA establishes the regulatory framework. The supervisor of large banks is the ECB, while for smaller banks supervision takes place locally, at national level. The guidance we give, particularly the guidelines for the supervisory review and evaluation process, also applies to all supervisors – to the ECB as well as to all national supervisors. We therefore aim to harmonise supervisory practices throughout the EU for all banks, not just those under the ECB’s supervision. On the other hand, the principle of proportionality is a very important aspect in all the regulations we create. I think that’s also something to keep in mind – that we can’t expect small banks, whose capacity is not as great as the larger banks, to suddenly come up with highly sophisticated methods of analysis. The principle of proportionality is therefore something we take very seriously, and a principle that we try to incorporate, but in such a way that we can still tackle the main risks facing institutions. In the specific context of environmental risks, it does not necessarily mean that small banks are not exposed to environmental risks. They are. In some cases, they could even be more exposed – for example, they may be more focused on certain sectors, depending on the business model and region in which they operate. But that is something that would have to be assessed on a case-by-case basis as part of the supervisory processes. Based on assessing the materiality of the risk, the supervisor would express expectations about what the level of risk management sophistication should be.

If large banks stopped financing activities that are not considered environmentally friendly – consequently penalising their capital ratios – customers involved in those activities would be able to turn to smaller banks willing to lend to them. Is that a risk to take into account?

This is very much a risk we are looking at, but perhaps in a broader context because, of course, those customers would look outside the banking sector; even the smaller banks are still regulated and still subject to supervision. So I think that the real risk here is that those businesses could go outside the system (looking for financing from other entities). I think that the goal of policies and of our paper is not for banks to stop financing businesses that engage in polluting activities, but to help them make the transition to being less polluting and, potentially, to becoming sustainable and contribute towards a sustainable economy. It’s therefore important that those areas continue to be financed. But that’s why there is so much focus on transition plans and why transition plans are discussed. In other words, the requirements for this transition lie in the legislative procedure that will be demanded of corporate entities and of banks. There is a very strong interconnection between the two things, of course, because the ultimate goal is to transform the economy into a sustainable economy. So simply closing our eyes and pushing things out of the system doesn’t solve anything. We need solutions that genuinely solve problems.

But it’s inevitable that some sectors won’t manage to make this transition, and some companies will get left behind, generating more non-performing loans (NPLs). Is that considered in the plans?

Of course. That is exactly the type of risk that we are looking at and which banks should keep in mind. There are risks and opportunities in any shift in the economy. There always have been and always will be winners and losers in the economy, across multiple sectors or when it comes to specific entities. This will also be transferred to banks’ balance sheets. Those risks and opportunities will be reflected in banks’ balance sheets. There will, as I said, be new business opportunities for banks where they may be able to make more profit. However, there are also areas that are riskier, and some businesses will always fail, which will generate NPLs for banks. But I would say that is one of the big questions we have raised in the discussion paper about the overall level of risk – whether the prudential framework is, in general, optimally calibrated right now. You can have two points of view on this. On the one hand, you could say that environmental risks are increasing, so the overall economic risk is increasing. That means that the overall risk to banks is greater, and therefore the optimal level of general capital requirements would also need to shift. On the other hand, the other point of view is the one I mentioned – that there are risks and opportunities. So, perhaps the impact of environmental risks is more about moving specific exposures between risk groups. As a result, some of them will be riskier and some of them will be less risky, but the overall level of capital requirements for the system as a whole is practically the same. So those are two different points of view. I don’t think there is one right answer to this question at the moment, but it is one of the fundamental questions we ask in the discussion paper and we hope to gather stakeholders’ opinions.

We might also say that there are some countries in the European Union (EU) that are more at risk of climate change than others. Some, such as Portugal and other southern European countries, will experience more forest fires, droughts and rising seawater in the coming decades. Should Europe have some sort of model to try to compensate for this?

At the EBA, we don’t normally take a country-by-country perspective; our focus is at EU-wide level in all the guidelines and regulations we are producing. These do not differentiate between countries and apply equally to all Member States and, specifically, to all the institutions to which they are addressed. But what you say is certainly true. There are obviously broader climate changes that are affecting different countries or regions, perhaps not necessarily at individual country level, but at regional level the impact may be different. This should of course be taken into consideration and acknowledged. I think being in the EU is of huge value – to be able to take action together to address these changes and direct the appropriate measures to where they are most needed. I hope that that is how environmental policy will be implemented in the EU. From our perspective, as I said, we look at the EU as a whole when it comes to risk differentiation and banks’ internal methods, but also the ways in which supervisors are analysing certain risks; what we are looking for is precisely these risk differentials. Here, the specific region may be one of the risk differentiation factors.

The interview was conducted by Filipe Alves

O Jornal Económico, 6 May 2022