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EU plans to lower capital requirements to boost banks' green investments

posted onJanuary 4, 2018

The European Commission said it is considering lowering capital requirements for banks’ environmentally-friendly investments in a bid to support sustainable finance and take action on climate change. “This could be done at first stage by lowering capital requirements for certain climate-friendly investments, such as energy-efficient mortgages or electric cars,”the EU executive’s vice president Valdis Dombrovskis said in a speech at the “One Planet” summit on climate change financing held in Paris in December.

The size of the possible capital reduction is under consideration. Currently, the EU grants capital reductions of 23.81 percent for banks’ exposures to small firms for investments below 1.5 million euros. The move could be part of a broader package of legislative measures the EU's executive arm plans to present in March to meet the target of cutting carbon emissions by 40 percent by 2030. To reach that target, Brussels estimates around 180 billion euro are needed in additional yearly low-carbon investments. Since this is well beyond the capacity of the public sector, private capital will also need to play its part. 

“The good news is that this is within the vast capacity of our financial system: together, asset managers and institutional investors manage about 35 trillion euros in Europe” Dombrovskis said.

But for private investors to fund the transition to the low-carbon economy, the EU need to put in place the right conditions and incentives. Dombrovskis also said that in a bid to spur the market for green financial products, the commission is working on an “ EU taxonomy - or a classification system” - for what is considered sustainable that “would allow us to define EU standards and labels for Green Bonds and Green Investment Funds. This would also allow us to address market fragmentation and accelerate green investments by all types of investors.” 

Green funds had around 145 billion euros of assets under management in 2016, against 3.1 trillion invested in European bonds and 3.4 trillion in equity funds, according to a report of an EU expert group on sustainable finance Reuters reported.

EU's plans came under criticism, as experts argue that banks need more equity, not less, in order to fulfil their key responsibility — namely to cushion risk, including for green investment.  Credit rating agency Moody's said in a statement: “The credit implications for affected banks would be negative, because the lower capital requirements would likely lead banks to hold less capital for exposures that feature similar risk characteristics as traditional loans or bonds”. It added “green investments may be in immature technologies not sufficiently tested or that can be quickly surpassed, and are exposed to high obsolescence risk.” 

Cristopher Thompson, Banking columnist at Reuters writes that Europe's banking system is still emerging from a decade-long legacy of bad debts and cheaper loans for, say, renewable energy companies would not make them any less dicey. In his opinion, “the bigger problem, however, is the lack of a rigorous definition for green assets. Such fogginess makes the label susceptible to abuse. Companies would have a big incentive to slap a “green” label on their loan applications.”  

Dombrovskis said Brussels would have to define rigorous criteria for what is green, to prevent banks gaming any initiatives the Financial Times reported.

Furthermore, a report by the European Banking Authority found that better capitalised banks have higher lending growth than the less capitalised banks. 

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