Stability and Sustainability in Banking Reform: Are Environmental Risks Missing in Basel III?

This report aims to trigger a deeper reflection amongst financial policymakers and regulators concerning the relevance of systemic environmental risks to banking sector stability.Recent history demonstrates linkages between risks arising both from the environment itself (e.g.extreme weather events) and from humanity's management of environmental resources (e.g.soil quality) and banking instability.Evidence suggests this trend will become more pronounced and complex as humanity breaches more planetary boundaries.However, international banking regulation (i.e. the Basel Capital Accord or 'Basel III') does not address the financial stability risks associated with systemic environmental risks.Nevertheless, a group of countries such as Brazil, China and Peru, along with their banking industries, have adopted regulatory and governance practices to address systemic environmental risks.The Basel Committee should learn more from their experiences and consider reforms to the Basel III Pillar 2 Supervisory Review framework and the Pillar 3 Market Discipline framework that would involve recognising systemic environmental risks as material risks that potentially threaten banking stability.In addition to Basel III, certain financial policies should be considered.Central bank monetary policy measures could enhance the provision of bank credit to environmentally sustainable economic activity.Also, the role of financial innovation should be considered as it relates to an array of credit risk transfer instruments that can be used to enhance the amount and quality of funding available for environmentally sustainable economic activity.Finally, financial policy and regulation should be aligned with environmental policy and regulation and coordinated so that the objectives and understanding of each area of expertise can be shared between the relevant agencies.This would create synergies for policy development and regulatory practices and standards.