Bridging Climate Change and Banking Law: A Path to Sustainable Financial Oversight

The IMF Working Paper explores how banking supervisory agencies can integrate climate risks into their mandates to ensure financial stability. It emphasizes the need for legal clarity and corporate governance adjustments to address climate risks, while promoting transparency through taxonomies and disclosures.

The IMF Working Paper prepared by researchers Mario Tamez, Ender Emre, and Alessandro Gullo from the International Monetary Fund, delves into the increasingly important relationship between climate change and banking supervisory law. This research underscores how banking supervisory agencies can integrate climate risks into their mandates, which are primarily focused on ensuring the safety and soundness of the banking system. Climate change, as identified by the scientific community, poses a significant threat to long-term global economic stability, and continued emissions at current levels are likely to result in irreversible environmental damage. The Paris Agreement, which seeks to limit global warming to below 2 degrees Celsius, has brought climate risks into the spotlight. However, it raises the question of what role banking supervisors can play in addressing these risks, given their responsibility for the stability of the financial sector.

Climate Risks and Financial Stability

The paper argues that the impact of climate risks on financial stability justifies the involvement of banking supervisory agencies. Climate-related risks, whether physical, such as extreme weather events, or transition risks related to regulatory changes or shifts in market sentiment, can directly affect the financial health of firms and the broader banking system. Therefore, addressing climate risks aligns with the core mandate of banking supervisors to ensure the soundness of financial institutions. The authors suggest that the existing legal frameworks of banking supervisory agencies already allow them to consider climate-related risks within their supervisory activities. Many supervisors around the world have started to incorporate climate risk assessments into their frameworks without requiring major legal reforms, relying instead on their broad mandates to safeguard financial stability.

Legal Certainty in Climate Risk Supervision

One of the central arguments of the paper is the need for legal clarity when it comes to the role of banking supervisors in addressing climate risks. While many agencies have embraced climate risk management as part of their broader prudential oversight, there are still gaps in legal frameworks that need to be addressed. Legal certainty is critical for ensuring that supervisory agencies can effectively integrate climate risks into their work without facing political or legal challenges. The researchers point out that although supervisors can act within their existing mandates, the absence of explicit legal provisions on climate risks in many jurisdictions can undermine their legitimacy in pursuing climate-related objectives. Consequently, the paper calls for greater alignment between legal mandates and the evolving role of supervisors in managing climate risks.

The Role of Corporate Governance in Climate Risk

Corporate governance also plays a crucial role in how banks manage climate risks. The paper highlights that banks' governance frameworks need to be adapted to ensure that decision-making processes consider the long-term impacts of climate change on financial stability. By embedding climate risks into their corporate governance structures, banks can better manage their exposure to these risks and capitalize on new market opportunities, such as financing for sustainable projects. Banking supervisors, in turn, have a responsibility to oversee how well banks are integrating climate risks into their governance models and business strategies.

Taxonomies and Disclosures as Critical Tools

Taxonomies and disclosure frameworks are identified as key tools for promoting transparency and accountability in the banking sector. Taxonomies help banks classify their activities based on environmental sustainability, which is essential for identifying risks and opportunities associated with climate change. Disclosure requirements, on the other hand, ensure that banks provide clear and comparable information about their climate-related exposures, enabling investors and regulators to make informed decisions. The paper acknowledges that implementing these frameworks presents challenges, particularly due to data gaps and the complexity of measuring climate risks. However, taxonomies and disclosures remain critical for advancing climate policies in the financial sector, and banking supervisors should play an active role in promoting their development.

International Agreements and the Role of Supervisors

The relationship between international climate agreements and national banking supervision is another area of focus. The paper notes that while governments are responsible for meeting the targets set by agreements like the Paris Agreement, banking supervisors also have a role to play in ensuring that the financial sector aligns with these global objectives. However, it is crucial to distinguish between the responsibilities of supervisors and those of governments. While supervisors are tasked with ensuring the stability of the banking system, it is ultimately up to banks to mobilize resources for climate-related projects. Supervisors should, however, ensure that banks are adequately managing the risks associated with climate change and are not exposed to undue financial vulnerabilities.

The paper argues for a pragmatic approach to integrating climate policies within banking supervisory mandates. While supervisors must prioritize the safety and soundness of financial institutions, they can also contribute to long-term climate goals by ensuring that banks consider climate risks in their decision-making processes. The authors advocate for ongoing dialogue between policymakers, supervisory agencies, and the private sector to refine legal frameworks and create a more coherent approach to managing climate risks in the financial system. The research highlights that although much progress has been made, further work is needed to fully integrate climate risks into the prudential frameworks that govern the banking sector, ensuring that both financial stability and climate objectives are achieved in the long run.