At the end of April 2024, the Basel Committee on Banking Supervision (BCBS) released a revised version of its most important document, the Core Principles for effective banking supervision. Whilst not all jurisdictions have adopted the Basel III banking supervision regime, the Core Principles target all financial supervisors globally. They serve as “the de facto minimum standard” for the “sound prudential regulation and supervision of banks and banking systems”. They are also “used by the International Monetary Fund (IMF) and the World Bank in the context of the Financial Sector Assessment Program (FSAP) to assess the effectiveness of countries’ banking supervisory systems and practices.” Non-compliance with these principles can therefore have a considerable impact on sovereign credit ratings and refinancing costs.
The revised Core Principles reinforce the need for preventive resilience-based supervision, taking a forward-looking approach to risk like climate-related financial risks explicitly into account and moving beyond relying mainly on backward-looking data for risk analysis and management. This finally brings in line the BCBS’s Core Principles with the need for forward looking risk based supervisory tools and approaches, which became prevalent in the 2007/2008 Global Financial Crisis, and which has become embedded into accounting standards such as IFRS 9 for high risk and non-performing exposures. The Core Principles thereby reinforce various guidelines and principles issued by the BCBS over recent years on how supervisors are expected to ensure that financial institutions assess and manage climate risks effectively.
To that end, acting across all three pillars of the Basel framework is key to ensure the effective regulation and supervision of climate-related risks. This includes:
- Ensuring that climate-related risk drivers and other associated risk drivers, such as nature-related risks, are included in the assessment of financial risks across all risk categories, and ensuring that these assessments are adequately reflected in the calculation of risk-weighted assets (RWAs) (Pillar 1);
- Defining and reviewing supervisory expectations on assessing and managing climate-related risks, including on transition planning; and the inclusion of climate risks in the Internal Capital Adequacy Assessment Process (ICAAP) (Pillar 2);
- Improving climate-related financial risk disclosures by updating disclosure standards, including issuing machine-readable disclosure templates that capture all climate risks (Pillar 3).
In our policy brief, we outline the activities undertaken so far by ASEAN+3 supervisors in this regard and recommend specific next steps for each Basel III pillar. ASEAN+3 economies are increasingly recognizing the importance of addressing climate-related financial risks within their supervisory frameworks.
Supporting tools to this end are initiatives such as the ASEAN Disaster Risk Financing and Insurance program (ADRFI) and the Southeast Asia Disaster Risk Insurance Facility (SEADRIF), which aim to strengthen the region’s resilience against disaster and climate risks. These efforts are complementary to the BCBS’s emphasis on incorporating climate-related financial risks into the supervisory process, as discussed in the Basel Committee’s holistic approach to addressing such risks.
Moving ahead, financial supervisors need to set clear standards and guidelines to ensure that climate-related financial risks and wider nature-related risks are firmly on top of the agenda of individual financial institutions and that the financial system builds up resiliency against these risks. Whilst adjusting regulatory and supervisory tools to tackle these risks might be challenging, not taking action will only escalate the risks in the medium term.
An early start to explicitly integrating climate-related financial risks across all three Basel III Pillars is key to enhance climate related data availability and quality, to strengthen assessment tools and methodologies, and thus safeguard financial stability.