At global level, the BCBS has published for consultation a paper on principles for the effective management and supervision of these risks.11 In any event, the improvement in banks’ management capability will presumably have to be supplemented by the development of a regulatory and prudential framework that properly takes into account the special features of the risks associated with climate change. There are two preliminary issues here: the existence of information and common taxonomies and the development of measurement methodologies. The need for common definitions and granular data To assess climate risks correctly, first it is necessary to have common definitions and data of sufficient quality and granularity. The Network for Greening the Financial System (NGFS), of which we, among 108 central banks and supervisory authorities from all over the world, are members, published in May 2021 a report12 emphasising the importance of having common worldwide definitions and standards for disclosure of information associated with these risks. Common definitions Owing to the complexity of the matter, the progress made towards establishing a global taxonomy is, unfortunately, still limited. Not only are productive technologies characterised by great heterogeneity at any given moment in time, which affects their environmental classification, but also a dynamic approach, which recognises the progress made in reducing their emissions, needs to be adopted. I would, however, like to stress the impetus the European Union has given to this issue, through the Taxonomy Regulation,13 which sets the foundations for a common European classification of “environmentally sustainable” economic activities. The regulation establishes six environmental objectives.

As deposits are readily available to depositors and many deposits are covered by a deposit guarantee, depositors accept a relatively low interest rate. The insurance premium banks pay for the deposit guarantee bears little relation to the risk the bank takes. In addition, since investors can expect that the authorities will come to the aid of banks in distress, they  BIS central bankers’ speeches  1  may be satisfied with a lower return. The result is an underpricing of risk, potentially leading to excessive risk-taking. Low equity ratios reduce loss-absorbing capacity and, at the same time, strengthen the incentive to take risks. While owners cannot lose more than their equity stake, there is a potential for high returns on the equity they have invested. To avoid a situation where banks hold inadequate equity capital, banks are subject to capital requirements. Each bank should hold capital in proportion to its risk exposure. This is the basis of microprudential bank regulation. But even if banks appear to be solid individually, the banking system as a whole may be vulnerable. Banks are exposed to one another and can inflict losses on one another directly. Banks can also suffer substantial losses indirectly if they have shared exposures outside of the banking system. This was clearly evident during the financial crisis. When a bank is forced to sell off assets, they fall in value. This weakens the balance sheets of other banks holding the same type of assets.