European Commission

• We quantify both the direct and the portfolio re-balancing impact, emphasizing the role of investor heterogeneity.
• We use proprietary security-level data on asset holdings of different investors.
• We measure the direct impact on security level, finding that it is smaller for securities predominantly held by more price-elastic investors, funds and banks.

• Abstract
  Amid the growing financial vulnerabilities posed by climate change, we investigate macroprudential capital buffers to mitigate systemic risks and increase the resilience of the banking
  sector.
• Subsequently, we introduce a methodological framework for tailoring bank-specific buffer requirements to cover these losses, offering macroprudential authorities a practical method for
  calibrating climate-related macroprudential capital buffers, complementing microprudential
  policies.
• The study demonstrates the potential of macroprudential capital buffers to mitigate potential climate-related losses and contributes to the
  understanding of the appropriate prudential policy response to these challenges.
• Second, we propose a calibration methodology for a macroprudential capital buffer which
  allows to address the build-up of climate-related systemic risks in the banking sector.
• The
  proposed calibration methodology assigns different systemic risk buffer requirements to banks
  in different buckets depending on each bank?s exposure to the estimated climate risks.
• Our findings highlight the potential systemic relevance of climate
  risks, while the proposed methodology demonstrates the potential of macroprudential capital
  buffers to mitigate climate-related losses.
• Overall, this paper makes a significant
  step towards operationalizing macroprudential capital buffers for climate-related risks, and can
  inform prudential authorities? reflections on how to concretly implement macroprudential tools
  to address the build-up of these risks.
• Yet, despite the growing consensus on the systemic features of climate risks,
  the discussion on the concrete implementation of macroprudential tools for climate risk is only
  incipient.
• This paper explores how climate risks should be accounted for in the regulatory framework,
  providing an analysis of how macroprudential capital buffers can be tailored to effectively address
  the systemic aspects of these specific risks.
• In Section 2, we discuss the current
  policy context around macroprudential policy targeting climate-related systemic risk, as well as
  the positioning of the paper in the existing academic literature.
• As part of the discussion on incorporating climate-related risk considerations into the prudential framework, macroprudential tools, including capital buffers, are increasingly being considered to address systemic aspects of climate-related risks, complementing microprudential
  measures.
• Yet, no common methodology currently exists to calibrate such buffer, which may hinder
  its actual use to address climate risks, should macroprudential authorities decide to use it.
• Our paper also contributes to the policy discussion by tackling some of the challenges
  which have been identified regarding the use of macroprudential tools for climate risks.
• In
  particular, ECB-ESRB (2022) identify the complex calibration as one of the hurdles to overcome
  in order to implement a climate SyRB.
• (2023) also estimate US banks? exposure to transition risk based on the carbon footprint of
  their syndicated loan portfolio.
• 7
  Similarly, earlier work by Campiglio (2016) suggests the use of green macroprudential policy in stimulating
  banks to finance low carbon activities.
• ECB Working Paper Series No 28xx

  10

  brown firms could actually even cause a reduction in lending to green firms via a crowding-out
  effect.

• We contribute to this literature by proposing a harmonized methodological framework,
  based on a stress test methodology and granular supervisory data, to quantify a macroprudential capital buffer requirement to tackle climate-related risks in the euro area banking sector.
• 23
  The extent to which the climate SyRB might overlap with other capital (buffer) requirements can also be
  used to inform macroprudential authorities? decision on the optimal calibration factor, as discussed in Section 3.3
  and 4.3.
• The proposed
  bucketing methodology also provides macroprudential authorities with sufficient flexibility to
  tailor the framework to the particularities of each jurisdiction (EBA, 2020).
• Finally, when implementing a bucketing approach, macroprudential authorities need to be
  mindful that such approaches have the potential to cause cliff effects.
• Hence, a
  bucketing approach translating bank-specific projected transition risk losses into capital addons appears to be both more prudent and more efficient.
• Assuming
  financial institutions do not hold additional provisions beyond the current policies scenario,
  transition risk losses will directly affect their capital positions.
• We define the excess CET1 ratio
  as the bank?s CET1 ratio minus the sum of all capital and buffer requirements (including P2G).
• The SyRB is therefore able to
  almost fully offset the impact of a transition shock on capital positions at the system-wide level.
• 31

  Assuming banks preserve their capital buffer in response to this increase in capital requirements.

• As an example, macroprudential authorities? assessment of the potential overlap of
  the climate SyRB with other capital (buffer) requirements may be helpful in this discussion.
• The scenario
  used for calibration of a macroprudential capital buffer like the SyRB will need to be chosen
  carefully to correctly identify realistic sources of systemic risk, including the potential interaction
  between transition risk and physical risk.
• Fourth, concrete implementation would need to ensure that macroprudential capital buffers are
  not targeting climate-related risks already covered by other microprudential or macroprudential
  capital (buffer) requirements, to avoid any overlap of requirements and double-counting of risks.

A month ahead of the European elections, EU institutions celebrate 74 years of European democracy with their citizens. Source : © European Union, 2024 - EP