Too early to impose capital charges on banks for climate risk

Requiring banks to hold capital to account for their climate-related financial risks may ultimately prove necessary, but a new report from the C.D. Howe Institute argues that climate data must improve and that Canada shouldn’t go it alone.

The Toronto-based think tank issued a report examining the idea of using capital requirements to ensure banks are adequately accounting for climate-related risks.

To date, proposed efforts from the Office of the Superintendent of Financial Institutions (OSFI) for tackling those risks do not include capital charges — although OSFI has indicated it expects climate-driven capital requirements to eventually form part of its response to the climate threat.

At this point, though, regulators are leaning on planned disclosure requirements, along with enhanced supervisory expectations in areas such as governance and risk management.

According to the C.D. Howe report, imposing capital charges for climate risks would be premature.

“The challenge is that measurement of climate risk is in its infancy and there is a fair amount of uncertainty and judgement required to impose prudential requirements,” the report said. “That reality means it is likely too soon to consider a Pillar 1 requirement imposing a uniform climate-risk calculation on all banks.”

Additionally, “adding capital to manage climate risk comes at a cost,” the report noted: higher capital demands increase banks’ funding costs and may curb their appetite for supplying credit.

Ultimately, climate change is a global issue, which requires a global response, the report also suggested.

To that end, it recommended that “any consideration of additional capital surcharges should involve Canadian authorities working with international peers through the the Basel Committee on Banking Supervision to agree on how best to incorporate climate risks.”

In the meantime, “improving climate risk assessment and disclosure can help mitigate the need for further capital surcharges,” the report suggested. “Establishing a common risk measurement and disclosure framework, as proposed by OSFI, would help to determine how best to factor climate risk into the capital plans of Canadian banks.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.