Central Bank Supervisory Role: Micro-Prudential Supervision and Regulation of ESG Risks

Abstract

Recent years have seen great strides in the deepening of our understanding of how sustainability factors – in particular those related to environment, society and governance (ESG) – may act as drivers of financial risks, and therefore are of relevance to institutions responsible for oversight of the financial sector. This chapter reviews these arguments in the context of the progressive inclusion of sustainability factors in microprudential regulation of the banking sector. New rules at international (Basel Committee for Banking Supervision, Network for Greening the Financial System), regional (European Union) and individual jurisdiction levels require that banks include ESG considerations in their governance. How such rules are implemented on the ground is contingent on the regulatory oversight architecture, that is how the responsibility for different objectives and financial sectors is repartitioned between different public authorities as well as the broader institutional framework the latter operate in. The chapter analyses from this perspective practices of microprudential supervisors in the EU (European Banking Union, Hungary, Sweden) and beyond (Brazil, United Kingdom) that are seen to be leaders in the trend, with view to distil the institutional factors shaping the ‘greening’ of supervision with regard to scope of prudential sustainability concerns and the instruments used. Four out of the five studied jurisdictions have delegated banking supervision to the central bank, which is interesting not least given the significant heterogeneity of financial supervision models globally. The chapter concludes with a discussion of the implications of the comparative analysis with regard to legitimacy (e.g. market overreach) and institutional implications (e.g. need for developed for accountability, institutional design) of micro-prudential supervision and regulation, in particular with regard to central banks.

Keywords: microprudential supervision, capital requirements, climate change risk, ESG risk, supervisors, ECB, Bank of England, Central Bank of Brazil

JEL Classification: G15, G18, G21, G32, K23