Sustainability Improvement Loans: A Risk-Based Approach To Changing Capital Requirements In Favour Of Sustainability Outcomes

Document summary

Policymakers are exploring whether to introduce Green Supporting Factors (GSFs) that would incentivise banks to lend to 'green' activities under capital requirement frameworks. This takes capital requirement frameworks away from their risk-based origins and this move is widely contested. This paper suggests an alternative pathway that satisfies the objective of aligning capital requirements with sustainability, while preserving their core role of supporting risk management. The authors introduce the concept of Sustainability Improvement Loans (SILs) that could merit lower capital charges as they are lower risk. A definition for SILs is given, as well as a demonstration of how they could incentivise sustainability practices as well as reduce risk. The potential pathway to policy application and its estimated effects on banks' capital and profitability is assessed, as well as the extent to which the policy is aligned with the financial stability objectives of central banks and financial supervisors.