Bank Capital Rules Are Holding Back Transition: Study

EBA analysis found that the models used by banks produce a lower risk rating for high carbon than low carbon sectors.

Backward-looking financial models are tilting the scales in favour of fossil fuels and holding back a fast, cost-effective energy transition in Europe, researchers from the University of Oxford have said.

Their study found that an implicit bias existed in financial accounting rules – a key driver of profitability for banks – which inflates the cost of divesting from high carbon industries towards renewables.

Under European financial regulations, banks must account for risk in firms and investments. Capital requirements, for example, force banks to hold higher capital buffers for investments that are estimated to be riskier.

However, analysis by the European Banking Authority (EBA) found that the statistical models that are widely used by banks to comply with these regulations produce a lower risk rating for high carbon (1.8%) than low carbon sectors (3.4%).

The difference was likely caused by the backward-looking nature of financial models, said researchers, disincentivising financial institutions from divesting their portfolios of high carbon assets.

The researchers have called for European financial regulations to be urgently updated to reflect future risk more accurately.

“Financial regulations are extremely important. They provide the guidelines for the financial system to work properly. However, financial regulations might have some side effects,” said lead author Matteo Gasparini of the Oxford Smith School of Enterprise the Environment and the Institute for New Economic Thinking at the Oxford Martin School.

“In this paper we show that some types of financial regulation might create disincentives to banks to divest from carbon intensive activities. By doing so they might slow down the investments required for a clean energy transition.”

Read more articles like this on Regulation Asia’s sister publication, ESG Investor.

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