Multiethnic group of people cooperating for environmental protection
elenabs

European legislators are proposing that banks face higher capital charges for their fossil fuel exposures as part of the fight against global warming. But amid the region’s energy crisis, Fitch Ratings said the plan will face pushback from finance ministers.

In a new report, the rating agency said that the European Parliament recently called for banks to face a 150% risk-weight for existing fossil fuel exposures, and an ultra-high 1,250% risk-weight for new (after Jan. 1 2022) exposures under revisions to capital requirements that are slated to take effect in 2025.

Fitch said that the proposal would impact banks’ capital charges for coal financing, natural gas and oil projects, including related transportation facilities and infrastructure.

Want more immediate, memorable insights? Listen to this Soundbites episode, featuring Dustin Haygood of Aristotle Capital Management.

“The European Parliament believes prudential regulators should reflect future climate-related transition risks, including regulatory depreciation charges, in current regulations to prevent a future shock to the financial system,” the rating agency noted.

However, Fitch said that the proposed ultra-high capital charge for new exposures could be viewed as going beyond just accounting for transition risks. It could also be viewed as actively promoting the transition to net zero.

This would run counter to financial regulators’ view of their roles, and may stoke a debate about whether bank regulators should be adding the fight against climate change to their mandates of overseeing the financial sector and ensuring financial stability, it noted.

“The head of the U.K.’s prudential supervisor, Sam Woods, recently said that addressing the causes of climate change is a decision for governments and parliaments, not regulators,” Fitch said, adding that the chair of the Basel Committee on Banking Supervision also said in July that regulators shouldn’t be using prudential requirements to meet climate-related objectives.

“As Woods warned, penalizing carbon-intensive exposures could also carry a risk of over-capitalizing banks inefficiently, reducing their ability to support the economy through the transition,” Fitch said.

If ultra-high capital charges are imposed, Fitch said that banks will avoid financing new fossil fuel exposures and will accelerate their divestment from existing projects, leaving the energy sector to seek funding elsewhere.

The prospects of strict measures in 2025 “could jeopardize bank funding for initiatives to address Europe’s energy crisis from 2022,” Fitch warned.

However, Fitch anticipates the European Parliament proposals will face pushback from finance ministers in the region. This would lead to either a “standstill or a watering-down to avoid clashing with the need to boost energy supplies amid the gas crisis in Europe.”