Banking regulation - in depth

Deep sea oil, dirty coal mining, obsolete nuclear plants, the arms trade, human rights abuses – your bank could be financing any number of environmentally and socially destructive businesses. But it doesn't have to be that way. The European Union is applying global recommendations for rules on banks, dubbed the 'Basel Recommendations'. These rules aim to make the banking system more robust and stable. However, the current recommendations, the Basel III, fall far short of their own objectives.

The rules do not yet address the responsibility of banks to actively assess and manage the social and environmental risks of their financial products, or the businesses they finance. Legislation should provide incentives and obligations to direct capital to green investments – and away from 'brown', unsustainable and irresponsible business. Dangerous financial products and practices, such as speculation on foodstuff derivatives, should be regulated, supervised and, if necessary, banned. Furthermore, a financial transaction tax should ensure that the financial sector pays its fair share to mitigate climate change, to tackle poverty and inequality, here and around the world, and last but not least, to cover the costs of its own crises.

Sustainability criteria

Friends of the Earth Europe calls upon the European Union to include sustainability criteria in the regulation of banking conduct, requirements for sound and safe banking (capital requirements), central bank capital reserves, and in remuneration and bonus schemes. This is the only way to ensure banks systematically integrate sustainability criteria into their lending, financing and investment decision-making processes. It would encourage them to reconsider unsustainable and dangerous investments, and to invest in more responsible and sustainable businesses such as renewable energy producers and social entrepreneurs.

We believe that large banks that assess their credit risks internally should differentiate the risk weighting factors they give their different categories of borrowers, according to their level of sustainability. As sustainable borrowers have a lower probability of default, their risk weighting factor should be lower. Non-sustainable categories, with higher probabilities of defaulting, should have higher risk weighting factors. Likewise, credit rating agencies, which provide credit risk assessments to many other banks, should integrate sustainability criteria in their credit rating and risk weighting factors. This would not affect the overall capital reserve level, but it would put banks that focus on sustainable borrowers at an advantage. Specific and penal capital requirements should be considered for banks providing credit to companies (or other investors in companies, like private equity funds) that grossly violate environmental and human rights standards.

As part of our work on banking regulation and sustainable financial systems, Friends of the Earth Europe is a member of the European cross-sectoral civil society network Make Finance Work – and of the civil-society expertise house Finance Watch. With them, we work towards stricter rules and fairer practices, to ensure that financial markets serve people and planet, not the other way around.