European Economy

Banks, Regulation, and the Real Sector

Numbers

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Authors

José Manuel Mansilla-Fernández[1]Public University of Navarre (UPNA) and Institute for Advanced Research in Business and Economics (INARBE).

 

Characteristics of Open Banking[2]We wish to thank Platformable for making their data available for our research.

Figure 1. APIs development by banks.

Notes: Own elaboration on Platformable and world Bank data. The figure reports the first 30 countries ordered by the ratio of the number of APIs developed by banks in the Platformable sample and the total number of banks in the country.

 

Figure 2a. APIs development by banks in different world regions.

 

Figure 2b. APIs development by banks in Europe.

Notes: Own elaboration on Platformable database. The vertical axis represents the average number of APIs developed by each bank of the sample. The whiskers represent the maximum and the minimum of the distribution. The box is divided into two parts by the median, i.e., the 50 percent of the distribution. The upper (lower) box represents the 25 percent of the sample greater (lower) than the median, i.e., the upper (lower) quartile. The mean of the distribution is represented by ×.

 

Figure 3: APIs development and bank size.

Notes: Own elaboration on Platformable database. Correlation between banks’ size measured as the natural logarithm of bank’s i total assets (Ln(Total assets)) in 2022Q3, which is represented in the horizontal axis, and the number of APIs in 2022Q3, which is represented in the vertical axis. The sample includes banks from Austria, Denmark, France, Greece, Ireland, Italy, The Netherlands, Spain, and the United Kingdom.

 

On FinTech companies

Figure 4: Use of FinTech-provided services.

Notes: Own elaboration on Platformable database. The vertical axis represents the different FinTech categories by functions. The horizontal axis represents the share of the number of FinTech companies included in Platformable by category. The sample includes FinTech companies from Europe, The United Kingdom, and the United States.

 

Figure 5: Users of FinTech-provided services.

Notes: Own elaboration on Platformable database. The horizontal axis represents different users of banking services provided by FinTech companies. The vertical axis the share of each users. The sample includes FinTech companies from Europe, The United Kingdom, and the United States.

Footnotes

Footnotes
↑1 Public University of Navarre (UPNA) and Institute for Advanced Research in Business and Economics (INARBE).
↑2 We wish to thank Platformable for making their data available for our research.

Institutions

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Authors

José Manuel Mansilla-Fernández

 

Open banking frameworks

Open banking is defined as the “sharing of customers’ permissioned information held by banks with so-called ‘third-party’ developers, who can use them to build applications and services comprising payments, synthetic information for account holders, and other marketing and cross-selling opportunities” (BIS, 2019).[1]The term ‘third party’ can be defined as ‘legal entities’, rather than supervised banks. More precisely, ‘third parties’ can be supervised banks and / or regulated companies, sellers, and … Continue reading

Many authorities are planning to take actions to regulate Open Banking in their jurisdictions. A large part is following a prescriptive approach, which mandates banks to share customers’ information with the aforementioned ‘third parties’ willing to access, as long as they are included in a register established by regulatory authorities. Other jurisdictions are instead adopting a facilitating approach, avoiding explicit requirements to make data available to ‘third parties’ but providing guidelines or recommendations, as well as suggesting common standards for the application programming interfaces (API) used to access the data, that the whole industry is invited to adopt. Lastly, other authorities are following a market-driven approach, setting no specific rules the sharing of customers’ information between banks and ‘third parties’ (BIS, 2019). [2]The European Union countries follow the prescriptive approach. Japan, Hong Kong, Singapore, and Republic of Korea adopted the facilitative approach. Argentina, the US and China follow the … Continue reading Overall, the regulatory framework is still embryonic in many jurisdictions, and activities by regulators, banks and market developers are still in at the initial stage (OECD, 2023).

A thorough Open Banking framework can include rules, standards and practices aimed at solving the many issues that are likely to emerge from such a pervasive data-sharing environment. Most jurisdictions take the perspective of customer protection from possible problems caused by allowing access to bank customer-permissioned data to unregulated third (and possibly fourth, if data are further transmitted to other corporations) parties (Bains et al., 2022). From this perspective, a range of different authorities are involved in regulating open banking, including: i) bank supervisors, in their traditional role of with respect to the activities of regulated banks (that are the producers of customer data); ii) technical standards setting bodies, that establish standards for automated access to customer permissioned data through API, with a special focus on security and standardization, requiring all involved entities to comply with them; iii) competition authorities, that monitor, encourage and take actions to ensure the well-functioning of markets; iv) data privacy authorities, responsible of ensuring the protection customer data; v) alternative dispute resolution mechanisms, responsible of mediating disputes between consumers and financial service providers (BIS, 2019).

 

The regulatory framework in the European Union

The revised PSD2 (Directive (EU) 2015/2366), adopted from January 13th 2018, standardizes payment services across the European Union (EU hereafter), and is the reference framework for the regulation of the payment sector.

Among other seminal provisions – e.g., detailed security transactions for electronic payments – the PSD2 also establishes the key concepts for the definition of Open Banking, by including in the regulation the Payment Initiation Services (PIS) and the Account Information Services (AIS). In this regard, the Directive clarify that the ‘competition-enhancing objective’ by regulating services operating as competitors to main banks.[3]Art. 108 of The Directive foresees reporting on the application of PSD2 to the European regulatory institutions, i.e., the European Parliament and the Council, the European Central Bank and the … Continue reading An important step in this direction was the reply by EBA to a question raised by the Bank of Ireland on the interpretation of the Directive, stating that an AISP is not limited to providing the consolidated information on the different account positions to the payment service user, but with the user’s consent it can also make this information available to third parties (EBA, 2021).

Despite the innovative content of PSD2, a recent document by EBA (2022) assessing the impact of PSD2 came to the conclusion that significant areas are still to be addressed so as to achieve the objectives to enhance competition, facilitate innovation, increase security of payment transactions, ensure the neutrality of the business model, and build a ‘single EU retail payment market’. In particular, the EBA proposes detailed interventions in four areas: 1) the prudential framework on licencing payment companies under the PSD2 regulation; 2) the responsibility of funds transferred by ‘third-parties’;[4]In particular, EBA proposes for the Directive: (i) not to take into consideration maximum limits for the amount to block payers’ accounts if the transaction is known, but introducing some … Continue reading 3) the application of Secured Customer Authentication (SCA), especially regarding the regulation of the merchant-inititaled transactions; 4) the need to address social engineering fraud risk by introducing requirements on educational and awareness campaigns, incentivising Payment Service Providers (PSP hereafter) to invest in monitoring mechanisms and sharing information among PSPs related to possible cases of fraud or fraudsters. Interestingly, regarding the need for ensuring the maximum degree of ‘financial inclusion’, the EBA suggests that the Directive introduces a general provision taking into account vulnerability of customers. The EBA also suggests enhancing attention and training on authentication procedures.

 

The British regulatory framework

The United Kingdom’s (UK) Open Banking Initiative constitutes a reference worldwide. The Open Banking Working Group (OBWG hereafter) was created in September 2015 by HM Treasury to assess whether bank data sharing may benefit the whole sector. The group consists of representatives of financial institutions, open data groups such as the Open Data Institute (ODI hereafter), as well as consumers’ associations and representatives of ‘third-party’ corporations. The following year, the Group suggested that standardized APIs would be a useful step to facilitate the sharing of information. In addition, it argued that a decentralised system of Open Banking would be safer than a single, centralised system.

The crucial year for Open Banking in UK is 2017. The PSD2 was transposed into legislation with The Payment Services Regulation and the Competition and Markets Authority (CMA) conducted a ‘Retail Banking Market Investigation’, that reached the conclusion that “older and larger banks do not have to compete hard enough for customers’ business, and smaller and newer banks find it difficult to grow. This means that many people are paying more than they should and are not benefiting from new services” (CMA, 2016). As a result, the CMA introduced a major open banking initiative aimed at enhancing innovation and competition within the banking sector, requiring the nine largest banks to “give their personal and business customers the ability to access and share their account data on an ongoing basis with an authorised [by the government] third parties” (see Taylor-Kerr, 2020). Here, the term ‘third party’ refers to banks and FinTechs. Furthermore, the aforementioned banks were required to enable third parties to make payment services authorised by customers’ banks, the so-called payment initiation. Importantly, the access to the data must be free to the petitioner (under customers’ permission), and banks are mandated to allow it (Babina et al., 2022).

In allowing banks to access customers’ information, regulators intend to create an environment where financial might propose new or improved financial services for customers and enhancing competing environment.

Lastly, the Open Banking Implementation Entity’s (OBIE hereafter), which was created in May 2020 after a thorough consultation process, adjusted the ‘Roadmap’. The process was conducted in two steps of consultation: i) open workshops, and ii) the assessment over 75 pieces of feedback from representative stakeholders, including the banks, third party suppliers, and user representatives.

 

Regulatory framework in other jurisdictions

As argued above, the regulatory framework of open banking is still embryonic in many jurisdictions. This section describes briefly the situation and perspectives of Open banking around the World.

The Australian government introduced the Consumer Data Right (CDR hereafter) legislation in 2017. The CDR applies to a broad range of customers’ data, including banking, energy, telecommunication data information, which are aimed at generating interoperability across sectors. Furthermore, the Australian Open Banking application is exclusively dealing with data, but not on payments. Additionally, the Australian Competition Consumer Commission (ACCC hereafter) assumes the supervisory role, which is equivalent to that of the CMA in the UK, while operating along the Australian Payments Network. In this regards, Andi White, CEO of the Australian Payments Network, stated that “the regulatory stance is about a balance of stability and innovation but there is a desire for good competition with the rise of challenger banks” (ACCC, 2023).

In Canada, a consultation was announced in 2017 to analyse the capabilities of Open Banking for their banking sector. In particular, an ‘Advisory Committee on Open Banking’ was appointed to conduct the analysis, along with a secretariat within the Department of Finance. In June 2019, the ‘Standing Senate Committee on Banking, Trade and Commerce’ launched a report entitled “Open Banking: What It Means For You”, which deals with a number of recommendations aimed at consolidating the Open Banking in Canada (World Bank, 2022).

The Hong Kong Monetary Authority (HKMA) released the “Open API Framework for the Hong Kong Banking Sector” in July 2018. The HKMA is intended to allow their banking industry to set their own criteria without making it a regulatory requirement (HKMA, 2018).

India released the Unified Payment Interface (UPI) in 2016, which is developed by the National Payments Corporation of India (NPCI). The UPI allows data transfer among financial institutions using a strong API environment that includes a digital identity solution which is still missing in most European and US jurisdictions/markets. Importantly, a new category of entities called Account Aggregators act as data fiduciary managing data requests from institutions that have a legitimate interest and the providers of information, and the consent of the data subject. The model is a clear representation of the regulatory approach. Importantly, it does not pre-judge the type of services the data receivers will offer, and allows all institutions regulated by any of the financial sector regulators in India and the Department of Revenue, Government of India to be able to participate as data receivers (see Natarajan, in this issue).

In Japan, the Amended Banking Act introduces a system for TPPs and establishes the environment for the banks-TPPs collaborations, in addition to other voluntary partnerships among banks to release ‘digital payments initiatives’. However, the activities of adopting ‘third parties’ are still in a preliminary phase, partly because of the difficulty in negotiating contracts between banks and FinTechs.

Mexico has implemented a model similar to the British one, but considering ‘premium’ versions for APIs. In March 2018, Mexico passed the ‘Financial Technology Institutions Law’ (The FinTech Law) aimed at regulating the FinTech and the Open Banking companies. The Mexican government is now finalising its implementation. The National Banking and Securities Commission will be the Open Banking regulatory framework, which is also intended to enhance innovation and financial inclusion (Greenberg and Traurig, 2020).

New Zealand implemented a model of Open Banking similar to the British one. The similarity results from the tight collaboration between both jurisdictions, conducted under the administration of the local payments associations, namely PaymentsNZ. Furthermore, New Zealand’s programme includes information about customers’ accounts and their payments (World Bank, 2022).

In Nigeria, the ‘Open Technology Foundation’ launched the Open Banking Nigeria (OBN hereafter) in 2018, which was aimed at fostering innovation in the Nigerian banking sector. OBN was intended to standardize open APIs as well as foster financial institutions and FinTechs to open their APIs protocols. Unlike other Open Banking jurisdictions, OBN regards excessive the British standards for the Nigerian purposes. Hopefully, Nigeria is designing suitable standards for the needs of their banking sector, and for other West African countries. The OBN’s API framework is expected to reduce the cost of innovation and to provide a good customer experience (Kassab and Laplante, 2022; ODI, 2020).

In Singapore, banks are encouraged to adopt APIs to accelerate the implementation of Open Banking. The Monetary Authority of Singapore (MAS hereafter) is not directly intervening, but together with the Association of Banks in Singapore has released an API typescript to encourage financial institutions to take part in the programme. As a result, several banks are launching their own API portals (e.g., Citibank, DBS, Standard Chartered, among others).

In the US, the so-called “NACHA’s API standardisation programme”, which was announced in 2017, focusses on three areas: i) fraud; ii) customers’ information sharing; iii) access to payment services. Additionally, the Consumer Financial Protection Bureau’s principles advice banks to include APIs for customers’ information sharing.

 

References

Australian Competition and Consumer Commission (ACCC) (2023). The consumer data rights. Available at: https://www.accc.gov.au/focus-areas/the-consumer-data-right (Accessed on 23 March 2023).

Babina, T., Buchak, G. and Gornall, W. (2022). Customer Data Access and Fintech Entry: Early Evidence from Open Banking. Mimeo.

Bains, P., Sugimoto, N., and Wilson, C. (2022). BigTech in Financial Services: Regulatory Approaches and Architecture, FinTech Notes. Available at: https://www.elibrary.imf.org/view/journals/063/2022/002/article-A001-en.xml (Accessed on 22 March 2023).
Badour, A., and Presta, D. (2018). Open Banking: Canadian and international developments. Banking & finance law review, 34(1): 41-47.

BIS (2019). Report on open banking and application programming interfaces. Basel Committee on Banking Supervision. Available at: https://www.bis.org/bcbs/publ/d486.pdf (Accessed on 15 February 2023).

Competition and Markets Authority (CMA) (2022). Retail banking market investigation. Avaulable at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1048212/Final_revised_Agreed_Arrangements_190122.pdf (Accessed on 22 March 2023).

Competition and Markets Authority (CMA) (2016). CMA paves the way for Open Banking revolution. Available at: https://www.gov.uk/government/news/cma-paves-the-way-for-open-banking-revolution (Accessed on 22 March 2023).

EBA (2022). Opinion of the European Banking Authority onitstechnicaladvice on thereview of Directive(EU) 2015/2366onpayment services in the internal market (PSD2). Available at: https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Opinions/2022/Opinion%20od%20PSD2%20review%20%28EBA-Op-2022-06%29/1036016/EBA%27s%20response%20to%20the%20Call%20for%20advice%20on%20the%20review%20of%20PSD2.pdf (Accessed on 15 February 2023).

EBA (2021). Guidelines on customer due diligence and the factors credit and financial institutions should consider when assessing the money laundering and terrorist financing risk associated with individual business relationships and occasional transactions (‘The ML/TF Risk Factors Guidelines’) under Articles 17 and 18(4) of Directive (EU) 2015/849. (Accessed on 22 March 2023). Available at: https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Guidelines/2021/963637/Final%20Report%20on%20Guidelines%20on%20revised%20ML%20TF%20Risk%20Factors.pdf

GreenbergTraurig (2020). New Open Banking Regulation in Mexico. Alert – Financial Regulatory & Compliance. Available at: https://www.gtlaw.com/en/insights/2020/6/open-banking-en-mexico-nueva-regulacion (Accessed on 23 March 2023).

Hong Kong Monetary Authority (2018). Open API Framework for the Hong Kong Banking Sector. Available at: https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180718e5a2.pdf (Accessed on 22 March 2023).

Kassab, M., and Laplante, P.A. (2022). Open Banking: What It Is, Where It’s at, and Where It’s Going. Computer, 55: 53-63 DOI: 10.1109/MC.2021.3108402.

Leong, E., and Gardner, J. (2022). Open Banking in the UK and Singapore: Open Possibilities for Enhancing Financial Inclusion. Journal of Business Law, 5: 424-453. DOI: http://dx.doi.org/10.2139/ssrn.4194256.

Natarajan, H. (2022). Regulatory Aspects of Open Banking: The Experience thus Far. European Economy. Banks Regulation, and the real Sector, this issue.

Open Data Institute (ODI) (2020). Open Banking preparing for lift off. Purpose, Progress & Potential. Available at: https://www.openbanking.org.uk/wp-content/uploads/open-banking-report-150719.pdf (Accessed on 23 March 2023).

OECD (2023). Data portability in open banking: Privacy and other cross-cutting issues. OECD Digital Economy Papers, No. 348, OECD Publishing, Paris, DOI: https://doi.org/10.1787/6c872949-en.

Parliament of Canada (2019). Open Banking: What it means for you. Senate, Ottawa, Ontario, Canada, K1A 0A4. Available at: https://sencanada.ca/content/sen/committee/421/BANC/reports/BANC_SS-11_Report_Final_E.pdf (Accessed on 2 March 2023).

Taylor-Kerr, A. J. (2020). Adopting Open Banking in Canada: An Analysis of Current Global Frameworks (Unpublished master’s project). University of Calgary, Calgary, AB. URI: http://hdl.handle.net/1880/114213

World Bank (2022). Technical Note on Open Banking. Comparative Study on Regulatory Approaches. Available at: https://elibrary.worldbank.org/doi/abs/10.1596/37483 (Accessed on 2 March 2023).

Legislation cited

The CDR Treasury Laws Amendment (Consumer Data Right) Act 2019. Available at: https://www.oaic.gov.au/consumer-data-right/cdr-legislation (Accessed on 15 February 2023).

Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC (Text with EEA relevance).

Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC.

Hong Kong Monetary Authority (2018). Open API Framework for the Hong Kong Banking Sector. Available at: https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180718e5a2.pdf (Accessed on 15 February 2023).

Japan. Act No. 59 of 1981, as amended (Banking Act). Available at: https://uk.practicallaw.thomsonreuters.com/w-007-5339?transitionType=Default&contextData=(sc.Default)&firstPage=true (Accessed on 15 February 2023).

Mexico. DECRETO por el que se expide la Ley para Regular las Instituciones de Tecnología Financiera y se reforman y adicionan diversas disposiciones de la Ley de Instituciones de Crédito, de la Ley del Mercado de Valores, de la Ley General de Organizaciones y Actividades Auxiliares del Crédito, de la Ley para la Transparencia y Ordenamiento de los Servicios Financieros, de la Ley para Regular las Sociedades de Información Crediticia, de la Ley de Protección y Defensa al Usuario de Servicios Financieros, de la Ley para Regular las Agrupaciones Financieras, de la Ley de la Comisión Nacional Bancaria y de Valores y, de la Ley Federal para la Prevención e Identificación de Operaciones con Recursos de Procedencia Ilícita. Available at: https://www.dof.gob.mx/nota_detalle.php?codigo=5515623&fecha=09/03/2018#gsc.tab=0 (Accessed on 15 February 2023).

Footnotes

Footnotes
↑1 The term ‘third party’ can be defined as ‘legal entities’, rather than supervised banks. More precisely, ‘third parties’ can be supervised banks and / or regulated companies, sellers, and other payment companies.
↑2 The European Union countries follow the prescriptive approach. Japan, Hong Kong, Singapore, and Republic of Korea adopted the facilitative approach. Argentina, the US and China follow the market-driven approach. Lastly, Brazil, Canada, Russia, and Turkey are in process of adopting their approach.
↑3 Art. 108 of The Directive foresees reporting on the application of PSD2 to the European regulatory institutions, i.e., the European Parliament and the Council, the European Central Bank and the Economic and Social Committee. In October 2021, the Commission’s ‘Call of Advice’, which was addressed to the EBA, was aimed at gathering information about the repercussions of the PSD2. The Art. 16a(4) of Regulation (EU) No 1093/2010 (EBA Regulation) establishes the EBA’s competence to give this opinion (see EBA 2021, 2022).
↑4 In particular, EBA proposes for the Directive: (i) not to take into consideration maximum limits for the amount to block payers’ accounts if the transaction is known, but introducing some requirements, (ii) to clarify the regulatory treatment of transactions when the final and the initial transactions are different; (iii) to clarify the distribution of responsibility between TPPs and and account service providers (ASPSPs) and between the issuing and acquiring PSPs when a secured customer authentication (SCA) exemption has been applied; and (iv) to clarify the terms ‘reasonable grounds to suspecting fraud’, ‘fraudulent act’, ‘gross negligence ‘and others, to avoid legal uncertainty and/or applying inconsistently the Directive regarding unauthorized transactions.

A Bird Eye (Re)view of Key Readings

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Authors

José Manuel Mansilla-Fernández

 

This journal section indicates a few briefly commented references that a non-expert reader might want to cover to obtain a first informed and broad view of the theme discussed in the current issue. These references are meant to provide an extensive, though not exhaustive, insight into the main topics of the debate. More detailed and specific references are available in each article published in the current issue.

 

On the functioning of Open Banking

Banking institutions allow access to their data through application programming interfaces (APIs hereafter) to third-party services providers (TSPs hereafter) to create new services, analytics, and financial products to improve customers’ services. In this regard, Open Banking is thought to support customer requirements and TSPs innovation to identify further customers’ needs and accelerate financial inclusion. The critical point is to preserve the privacy of depositors, borrowers, investors, and other types of personal information (PI). When disclosing APIs to TSPs, financial institutions might be afraid due to possible attacks to their customers by malicious software (Liao et al., 2022).

Notably, APIs can be defined as mechanisms through which computers communicate with each other using common languages. Software systems operate among themselves through standardized protocols and standard interfaces (Cowhey et al., 2009). In this regard, APIs enable such interfaces to communicate with one another, making information and contents approachable (Bodle, 2011). Furthermore, APIs technologies reduce abstraction and complexity, allowing API-consuming systems to communicate without previous conditions regarding the origin of the applications (Zachariadis and Ozcan, 2017).

Interestingly, the banking industry is experiencing a process of platformization, in which technology is used to connect people, organisations and resources in an interactive ecosystem (Parker et al, 2016; Van Dijck et al., 2014, 2018). Formally speaking, Open Banking, has been expanded worldwide, and it has become one of the most prominent strengths of the banking industry (Brackert et al., 2019; Ziegler, 2021). The cornerstone of Open Banking is to ensure sharing, provided there is consent. Interestingly, despite this simple process, data-sharing rights might be the main limitation for fostering the revolution of the banking industry from the conventional business models to ‘open platforms’, as happened in other industries such as the telecommunication sector (Babina et al., 2022; Westermeier, 2020). Indeed, platform-business models might have repercussions on competition since they rely on network externalities, as further discussed in the next section (Barba Navaretti et al., this issue).

Open Banking encourages innovation between financial institutions and TSPs. Consequently, customers’ account transactions are regarded as ‘banks’ assets’, but Open Banking allows customers to share their information with other TSPs through APIs (Almehrej, et al., 2020). Interestingly, the Open Banking Implementation Entity (OBIE) aimed to develop APIs standards for Open Banking in the UK. The OBIE requires British banks to verify TSPs (consent) access to users’ data. Liao et al. (2022: 451) identify the following three phases to implementing Open Banking:

  1. Requiring public information about time deposit interests, currency exchange, and mortgage interest rates. This information, which banks must post, must be verifiable by users.
  2. TSPs will access users’ data to supply integrated account services. This phase focuses on customers’ information, e.g., their deposits, credit, and investments for multiple banks integrated into a single set.
  3. Lastly, users can link payments and funds among different sources via ATP-providers Apps. This phase focuses on transaction information about loan repayments, authorisations, and several types of transactions.

An essential issue in Open Banking is that of security and data protection. Interestingly, blockchains which distribute digital blocks containing cryptographic linking information, can help protect customers’ privacy, ensure the safety of transactions, and provide safe scenarios, particularly for third parties (Chen et al., 2016; Chiu et al., 2021).[1]An example is Ethereum blockchain platform is an example of smart-contact (SC hereafter), which might improve control over customers’ changes of authorisations (Liao et al., 2022). Wang et al. (2020) assess methodologies employed to classify data privacy and ‘disclosure schemes’ for protecting customers’ privacy, which must concord with possible deficiencies in Open Banking blockchain, e.g., privacy-preserving granularity, over-complexities of banking subsystems, or hierarchical data management. Mukhopadhyay and Ghosh (2021), based on a systematic customer consent management analysis, set up a TPST classification to facilitate customers making consent decisions. Noting that private information has higher standards of authentication and requirements, Xu et al. (2020) built a considerable data-sharing model to ease banks and customers access to TSP information. Based on an analysis of security risks, Zhang et al. (2019) propose a data-sharing scheme and API agreement to safeguard APIs from malware. Likewise, Dong et al. (2020) describe that a blockchain-based SSI model wbhci might be able to address data privacy issues, involving registry and controlling contracts to enhance user identity changes.

 

The impact of Open Banking on competition

Economic literature usually compares traditional banks and FinTech companies when competing.

He et al. (2022a,b,) develop a model in which Open Banking may enhance credit competition between banks and FinTech companies by augmenting banks’ and FinTechs’ efficiency in screening borrowers. Accordingly, customers with higher creditworthiness will have better access to credit than those relatively worse classified. A key element of Open Banking is that customers keep control of the data they are willing to share with third-parties, which can reveal information about their creditworthiness. Lastly, Open Banking can disclose non-financial information about (FinTech) lenders. Nonetheless, little is known about how FinTechs can make relatively more targeted credit offers which can impact competition.

The irruption of FinTech (e.g., Vives, 2019) changed the sources of information production and diffusion.[2]The term Open Banking refers to data sharing of customers’ information that banks possess with the so-called ‘third-party’ (See Instititution in this issue), whereas the concept of FinTech … Continue reading Berg et al. (2020, 2021) show that digital footprints – which refers to the trail of data that a person leaves on the Internet, including visits to websites, emails, etc. – might be a valuable tool to predict consumers’ default and it might be a complementary source to traditional credit agencies. Similarly, Fuster et al. (2019) assess the mortgage credit market and show that FinTech lenders’ advantages from technology augment their origination efficiencies. Remarkably, Di Maggio and Yao (2021) show that FinTech lenders grant to borrowers of relatively better creditworthiness by financing consumer credit, who later on default ex post more frequently than similar borrowers applying to other lenders. Di Maggio et al. (2022) suggest that some borrowers wishing immediate consumption apply to FinTechs, thus exacerbating their self-control issue over overborrow.

Focusing explicitly on Open Banking, Parlour et al. (2022) investigate the case of a bank operating in both payments and credit markets. The authors assume that the bank is a monopolist in the credit market but competing with another stand-alone FinTech on payment services. A crucial assumption is that customers’ payment services provide information about their creditworthiness. Within this framework, customers might anticipate that changing their payment service to FinTech might impact their credit service. Notwithstanding, there is no implication on the equilibrium of credit quality.

On the empirical side, Buchak et al. (2018) investigates the mortgage market and explain that advances in banking regulation significantly contributed to growing FinTechs. Besides, Tang (2019) introduces a regulatory ‘shock’ that shortens bank credit to find that peer-to-peer (P2P) platforms can substitute banks in the consumer credit segment. On th supply side, Feyen et al. (2022c) conducted a survey that reveals that banks and Fintechs do not see each other as competitors. Likewise, Fintech firms expect to compete with their counterparts like BigTechs, platforms, or aggregators; whereas banks see neo-banks as their competitors. However, economies of scale and network economies are expected to consolidate large multi-product institutions, e.g., large banks, FinTechs, and BigTechs (Feyen et al., 2022a,b).

Babina et al. (2022) recently studied open banking using a handful of data sources, including hand-collected data. Their findings show little effect of open banking on competition in the banking sector. They provide two main explanations of this result. First, the phenomenon of OB is still embryonic and data are not entirely reliable. Second, real effects can take a while to be visible substantially. Interestingly, they find that Open Banking might reduce adverse selection against new entrants and augment formers’ product quality. Consequently, Open Banking fosters innovation. These results suggest two interesting areas for policymakers. First, Open Banking diminishes banks’ incentives to generate value by capturing customers’ data. Secondly, ‘data sharing’ hurt customers who opt-out from sharing might be harmed since they might be perceived as credit-worthless borrowers, i.e., they are sending negative signals to the market. Consequently, the effects can be unpredictable because Open Banking data can be used to screen potential renters and customers who are unwilling to share information about their levels of risk, thus being removed from ‘basic housing markets’.

 

Financial inclusion and consumer protection

Financial inclusion can be defined as a measure of the degree to which individuals and companies can access financial services. The maintained assumption is that financial inclusion can substantially improve people’s well-being. Digital financial services might offer important opportunities for inclusion and resilience. In this regard, financial literacy and digital skills play an important role in correctly managing the aforementioned financial applications from a young age (Bianco et al., 2022).

The economic literature suggests that the market equilibrium depends on the context of consumer privacy preferences. Jones and Tonetti’s (2020) theoretical model shows that consumers’ data ownership frequently leads to broader data management than firm ownership, thus enhancing welfare due to the non-rivalry of such usage. Likewise, Ichihashi (2020) shows that sellers might use consumers’ information, particularly when revealing their preferences, to recommend specific products and implement price discrimination, the so-called multi-product monopoly. More precisely, they show that the seller is incentivized not to discriminate consumers in price to encourage consumers to share their information, but it harms consumers in equilibrium since firms might set constant prices anticipating the clearing of the market. Similarly, Ali et al. (2022) find that sharing information about preferences with firms might amplify price competition and benefit consumers. Interestingly, Liu et al. (2020) analyze the implications of consumers’ privacy when introducing a ‘consumption good’ and a ‘temptation good’. Data sharing might manipulate consumers’ behaviour, improving the efficiency of the ‘consumption good’, but inducing behaviorally biased consumption towards the ‘temptation good’. In particular, Ali et al. (2022) emphasize differences between the EU consumer privacy regulation, namely General Data Protection Regulation (preferred opt-out choice), and the California Consumer Privacy Act (opt-in preferred choice) (see also Kshetri and Voas, 2020).

 

References

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Berg, T., Burg, V., Gombović, A., and Puri, M. (2020). On the rise of fintechs: Credit scoring using digital footprints. Review of Financial Studies, 33: 2845-2897.

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Bianco, M., Marconi, D., Romagnoli, A., and Stacchini, M. (2022). Challenges for financial inclusion: the role for financial education and new directions. Questioni di Economia e Finanza (Occasional Papers) 723, Bank of Italy, Economic Research and International Relations Area. Available at: https://www.bancaditalia.it/pubblicazioni/qef/2022-0723/QEF_723_22.pdf

Bodle, R. (2011). REGIMES OF SHARING, Information, Communication & Society, 14: 320-337.

Brackert T, Chen C, Colado J, Desmangles L, Dupas M, Roussel P. The race for relevance and scale. Boston Consulting Group; 2019 [cited 2022 Sep 17]. Available from: https://www.bcg.com/publications/2019/global-retail-banking-race-for-relevance-scale.

Buchak, G, Matvos, G., Piskorski, T., and Seru, A. (2018). Fintech, regulatory arbitrage, and the rise of shadow banks, Journal of Financial Economics, 130: 453-483.

Chen M., Qian Y., Chen J., Hwang K., Mao S., and Hu L. (2016). Privacy protection and intrusion avoidance for cloudlet-based medical data sharing. IEEE Transition on Cloud Computing.

Chiu W.-Y., Meng W., and Jensen C.D. (2021). My data, my control: A secure data sharing and access scheme over blockchain. Journal of Information Security and Applications, 63, Article 103020

Cowhey, P. F., Aronson, J. D. and Abelson, D. (2009) Transforming Global Information and Communication Markets: The Political Economy of Innovation, Cambridge, MA: The MIT Press.

Daiy A.K., Shen K.-Y., Huang J.-Y., and Lin T.M.-Y. (2021). A hybrid MCDM model for evaluating open banking business partners. Mathematics, 9: 587.

Di Maggio, M., and Yao, V. (2021). Fintech borrowers: Lax-screening or cream-skimming? The Review of Financial Studies, 34: 4565-4618.

Di Maggio, M., Ratnadiwakara, D., and Carmichael, D. (2022). Invisible primes: Fintech lending with alternative data. NBER Working Paper 29840. DOI: 10.3386/w29840.

Dong C., Wang Z., Chen S., and Xiang Y. (2020). BBM: A blockchain-based model for open banking via self-sovereign identity. International Conference on Blockchain, Springer: 61-75.

Feyen, E.H.B., Frost, J., Gambacorta, L., Natarajan, H., and Saal, M. (2022a). Fintech and the Digital Transformation of Financial Services – Implications for Market Structure and Public Policy (English). Washington, D.C. : World Bank Group. Available at: http://documents.worldbank.org/curated/en/099735304212236910/P17300608cded602c0a6190f4b8caaa97a1

Feyen, E.H.B.; Natarajan, H., and Saal, M.(2022b). Fintech and the Future of Finance – Overview (English). Washington, D.C. : World Bank Group. Available at: http://documents.worldbank.org/curated/en/099450005162250110/P17300600228b70070914b0b5edf26e2f9f

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Footnotes

Footnotes
↑1 An example is Ethereum blockchain platform is an example of smart-contact (SC hereafter), which might improve control over customers’ changes of authorisations (Liao et al., 2022).
↑2 The term Open Banking refers to data sharing of customers’ information that banks possess with the so-called ‘third-party’ (See Instititution in this issue), whereas the concept of FinTech focusses on the (Internet-based) technology (see Institutions of the 2017.2 issue of European Economy) that might allow lenders and/or ‘third parties’ to process the aforementioned customers’ information.

A Bird Eye (Re)view of Key Readings

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This journal section indicates a few and briefly commented references that a non-expert reader may want to cover to obtain a first informed and broad view of the theme discussed in the current issue. These references are meant to provide an extensive, though not exhaustive, insight into the main topics of the debate. More detailed and specific references are available in each article published in the current issue.

On the relevance of climate change risks

Understanding the effects of climate change on the financial system has emerged as one of the forefront issues globally (Hong et al., 2019, 2020). Climate change is believed to increase the frequency and intensity of extreme weather events, raise average temperatures, and rising sea levels. Importantly, climate change already impacts economic and financial outcomes, which might have negative repercussions on financial systems. Correlated risks from climate change shocks could have effects beyond individual banks and borrowers to the broader financial system and economy. In this regard, in the pricing of residential mortgages does not incorporate climate change risks, a sudden correction could result in large-scale losses to banks, leading to reduced lending supply and jeopardizing financial stability. The subsequent declines in wealth could amplify the effects of climate change on the real economy, thus producing knock-on effects on financial markets (Nguyen et al., 2021).

Financial institutions must assess their vulnerabilities to relevant climate risks, as well as risks’ likely persistent and breadth, to be able to continue meeting the financial needs of households and companies when hit by disruptions caused by climate change. Remarkably, considering climate risks is relevant from the regulatory point of view. In this vein, the Federal Reserve created a dedicated supervision climate committee to observe the risks of climate change to individual banks. Likewise, the Bank of England expects its banks to understand and assess the financial risks related to climate change (Nguyen et al., 2021).

The recent studies are focused on exploring the ex-post effects of acute hazards, e.g., storms, floods, wildfires, on banks. In this regard, North and Schüwer (2018) show that natural disasters weaken financial stability. Similarly, Issler et al. (2020) find an augment in mortgage delinquency and foreclosure after wildfires. Ouazad and Kahn (2021) find that lenders are more likely to approve mortgages that can be securitized after hurricanes. Unlike acute hazards, the chronic ones -e.g., slow increases in sea levels- introduce the possibility that losses may arise from natural disasters. Despite the risk of chronic hazards causing losses, economists still know little about how such risks are priced ex-ante by banks. Consequently, more research is needed to understand how climate risk can be priced -ante by financial institutions, particularly the pricing of loans.

Interestingly, banks may not be able to price long-term climate change risks. The Board of Governors of the Federal Reserve System (2020a, b) estates that banks’ models still lack the necessary geographic precision or horizons to price climate risks. Another challenge can be uncertainty regarding the time horizon over climate risk can be materialized (Barnett et al., 2020). Furthermore, many banks still rely on traditional backward-looking models based on historical exposures, which might not adequately reflect climate risks’ complex and continuous changing nature. Moreover, considering the set of risks that banks are currently facing -e.g., cybersecurity, geopolitical risks, and risks associated with the credit cycle-along with the relative long-term horizon around climate change and risk (Nyberg and Wright, 2015). For instance, sea levels rise is a non-conventional risk and therefore, lenders pay equal attention to this risk or incorporate it into their pricing loan decisions (Jiang et al., 2020).

On carbon pricing and its repercussions on lending

Research on carbon risk is still embryonic. Stranded assets are physical assets whose value declines substantially due to climate risk. The carbon reduction requirements in the Paris Agreement and the policies oriented to fossil fuel firms might not be able to fully utilize their existing fossil fuel reserves (McGlade and Ekins, 2015), leading to a decline in the financial values of such reserves. The carbon risk from stranded assets in the fossil fuel industry can be priced, which constitutes an approach for assessing climate-related financial risks. However, carbon risk goes beyond stranded assets. Firms issuing large volumes of carbon are relatively more likely to suffer financial penalties if environmental policies tighten. Direct penalties can result from additional costs of carbon taxes on firms’ emissions. These can apply to firms in all industries with a carbon footprint and are not limited to fossil fuels producers (Ehlers et al., 2021).

The pricing of carbon risk in the loan markets changed significantly after the Paris Agreement.[1]See the Institutions section in this issue. The difference in risk premia due to carbon emission intensity is apparently across industry sectors. Additionally, this phenomenon is broader than simply stranded assets in fossil fuel emissions or other carbon-intensive industries. Including loans fees and the premium is not prevalent in the years before the Paris Agreement, which increased banks’ awareness of carbon risk (Krueger et al., 2020). However, Delis et al. (2021) assess syndicated loan data for fossil fuel firms to investigate whether banks price the risk of stranded assets.[2]The corporate loan market, and specially the syndicated loans markets, constitutes an ideal laboratory to test hypotheses about the effects of climate change / risk on loan pricing, because banks … Continue reading They reveal that only after the 2015 Paris Agreement banks started pricing the risk of stranded assets related to fossil fuel reserves. Similarly, Kleimeier and Viehs (2018) also use syndicated loans data to investigate if forms voluntarily disclose their carbon emissions to the Carbon Disclosure Project, which allows them to reduce their cost of credit compared to non-disclosing firms. This result supportcs Antoniou et al. (2020), who theoretically find that loans spreads for firms participating in cap-and-trade programs function the cost of compliance and the specific features of the permits markets. Using the EU Emission Trading System, which is designed to pass the cost of CO2 emissions to polluters, this study suggests that the higher permits storage and lower permit prices, the lower firm financing costs.

Importantly, banks have started to internalize possible risks from the transition to a low-carbon economy across various industries. Krueger et al. (2020) suggest that carbon emissions indirectly caused by production inputs were not priced at the margin, suggesting that the overall carbon footprint is less of a concern to banks those direct missions. Likewise, Bolton and Kacperczyk (2021) find that the likelihood of disinvestment by institutional investors significantly augments with the degree and intensity of emissions directly attributable to firms. This suggests potential for ‘green-washing’ since the aforementioned emissions mentioned above can be reduced simply by outsourcing carbon-intensive activities withoutlowering the firm’s carbon footprint (Ben-David et al., 2018).

On the impact of climate change on equity markets

So far, research on the pricing of climate change risk, including carbon risk, has focused on the pricing of climate-related risks in equity markets. Recently, economists indicated that a transition risk premium in equity and option markets, which seems to be more pronounced in times of high climate change awareness. Mainly, the price of protection of option securities against the downside tail risk is higher for carbon-intense firms. In this regard, Bolton and Kacperczyk (2021) identify a carbon premium in the cross-section of the US stock market over the last decade. Particularly, the 2016 US climate policy shocks (the Trump election who appointed Scott Pruit, a climate sceptic, as administrator of the US Environmental Protection Agency) provide additional evidence that firms’ exposure impacts on their stock market valuation (Ramelli et al., 2021). Consequently, the valuation of carbon-intense firms rose. Goergen et al., (2020) assess carbon risk measures based on the firm’s overall strategy and its operational exposure to transition risk, including carbon emissions. Although they find that carbon risk is a priced risk factor, it does not find any evidence for a carbon premium in the global equity market.

On the capacity of banks to boost the climate change

As major providers of credit, banks are the key players in the effort to transition from a brown to a green economy. The momentum established by the COP21 enlarges the set of investment opportunities to finance green projects and renewable energy. Indeed, investment in the green economy has recently increased and is expected to grow enormously in market share (IEA, 2015; International Renewable Energy Agency, 2016). This increase is motivated by a growing consensus that supports movements towards a low-carbon economy and technological improvements that will lead to cost reductions in renewable energy, making alternatives to fossil fuel more appealing (Mazzucati and Perez, 2015; Krueger et al., 2015).

This might raise the question of how climate risks might directly impact financial institutions. Importantly, banks take on new risks in this regard, particularly physical and transition risks. On the one hand, physical risks arise from weather and climate-related disasters (Nordhaus, 1977; Stern, 2008; Nordhaus, 2019). These events can damage properties, reduce agricultural productivity, and impact deleteriously on human assets (Deryugina and Hsiang, 2014; O’Neil et al., 2017). Should this reduce the firms’ profitability and deteriorate their balance sheets, banks would be negatively affected in terms of asset values, collateral quality, and credit risk exposure. Furthermore, banks suffering large losses could diminish their lending availability, thus exacerbating the financial impact of physical risks by reducing credit supply. The blossoming literature provides theoretical and empirical evidence that banks should consider such physical risks in their investment decisions. Accordingly, Addoum et al. (2019) and Pankratz et al. (2019) show a negative correlation between firms exposed to extreme temperatures and profitability. Balvers et al. (2017) find that firms suffering from relatively high temperatures have higher cost of capital. This result connects with the literature advocating that extreme weather events are incorporated to stock and option markets (Dell et al., 2014; Kruttli etal., 2019; Choi et al., 2020).

On the other hand, banks should face transition risks that might arise from adjustments made toward developing a green economy. Particularly, transition risk depends on the timing and the speed of the process. Unanticipated changes in climate polices, regulations, technologies, and market sentiment could reprice the value of bank assets (CISL, 2019; Hong et al., 2019). Consequently, banks exposed to climate-sensitive sectors might be forced to fire carbon-intensive assets, leading to liquidity problems (Pereira da Silva, 2019). Therefore, this could create uncertainty and procyclicality and increase banks’ market risk (BoE, 2018). Transition risks could impact on bank credit risk if new technologies or changes in consumer behaviour towards “environmentally friendly” sectors lowered carbon-intensive firms’ profitability, further increasing their default risk (Krueger et al., 2020). Reghezza et al. (2021) analyse whether climate-oriented regulatory policies impact the flow of credit towards polluting corporations. Following the Paris Agreement, they find that European banks reallocated credit away from polluting companies. Consequently, green regulatory initiatives in banking can significantly impact on combating climate change.

Importantly, the COP21 is expected to impact the banking sector’s decisions. De Greiff et al. (2018) and Degryse et al. (2020a, b) assess the effect of climate risks on pricing in the syndicated loans. Since the COP21, banks have charged a premium for climate risk driven by increased awareness of climate policy-related risks. In particular, green firms have borrowed at comparatively lower prices since COP21 came into force.
Likewise, Delis et al. (2018) analysed the risk stemming from stranded fossil reserves, suggesting that, after 2015, banks started to price climate policy exposure by raising the cost of credit due to their awareness of transition risk. Ilhan et al. (2018), using a sample of high-emission industries in the S&P 500 before and after COP21, find that investors already incorporate information on climate-related risks when assessing risk profiles. Ginglinger and Moreau (2020) show that, after COP21, French companies subject to large climate risks reduced their leverage.

Regarding the financial system structure, De Haas and Popov (2019) find evidence of relatively lower CO2 emissions in more equity-funded economies, and they argue that stock markets contribute to reallocating investments toward less polluting industries. Similarly, Mesonnier (2019) investigates whether French banks reallocate credit from low intensive industries over the 2010-2017 period. They find that French banks reduce credit provision to more polluting industries.

References

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Barnett, M., Brock, W., and Hansen, L. P. (2020). Pricing uncertainty induced by climate change. Review of Financial Studies, 33: 1024-1066.

Ben-David, I., Franzoni, F., and Moussawi, R. (2018). Do ETFs Increase Volatility? Journal of Finance, 73: 2471-2535.

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BoE (2018). Transition in thinking: The impact of climate change on the UK banking sector. Bank of England Report, September 2018.

Bolton, P., and Kacperczyk, M.T. (2020). Do investors care about carbon risk? Journal of Financial Economics, 142: 517-549.

Choi, D., Gao, Z., and Jiang, W. (2020). Attention to global warming. The Review of Financial Studies, 33: 1112-1145.

CISL (2019). Unhedgeable risk: How climate change sentiment impacts investment. Cambridge Institute for Sustainability Leadership, Cambridge.

De Greiff, K., Ehlers, T. and Packer, F. (2018). The pricing and term structure of environmental risk in syndicated loans. Mimeo, Bank for International Settlements.

De Haas, R. and Popov, A. (2019). Finance and Carbon Emissions. ECB Working Paper Series, No 2318. Available at: https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2318~44719344e8.en.pdf (Accessed on February 2, 2022).

Degryse, H., Goncharenko, R., Theunisz, C. and Vadasz, T. (2020). When green meets green. Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=16536

Degryse, H., Roukny, T. and Tielens, J. (2020), Banking barriers to the green economy. NBB Working Papers, No 391. Available at: https://www.nbb.be/en/articles/banking-barriers-green-economy (Accessed on February 2, 2022).

Delis, D. de Greiff, K., Iosifidi, M., and Ongena, S. (2021). Being Stranded with Fossil Fuel Reserves? Climate Policy Risk and the Pricing of Bank Loans. Swiss Finance Institute Research Paper No. 18-10. DOI: http://dx.doi.org/10.2139/ssrn.3125017

Delis, M., De Greiff, K., and Ongena, S. (2018). Being stranded on the carbon bubble? Climate policy risk and the pricing of bank loans. Swiss Finance Institute Research Paper Series, No 18-10, Swiss Finance Institute. DOI: http://dx.doi.org/10.2139/ssrn.3125017

Dell, M., Jones, F. B., and Olken, B. (2014). What do we learn from the weather? The new climate-economy literature. Journal of Economic Perspective, 52: 740-798.

Deryugina, T., and Hsiang, M. S. (2014). Does the environment still matter? Daily temperature and income in the United States. NBER Working Papers, No 20750, National Bureau of Economic Research, December. DOI 10.3386/w20750

Ehlers, T., Packer, F., and Greiff, K. (2021). The pricing of carbon risk in syndicated loans: which risks are priced and why? BIS Working Papers No 946. Available at: https://www.bis.org/publ/work946.pdf (Accessed on February 2, 2022).

Ginglinger, D., and Moreau, Q. (2019). Climate risk and capital structure. Mimeo.

Goergen, M., Jacob, A., Nerlinger, M., Riordan, R., Rohleder, M., and Wilkens, M. (2020). Carbon risk. Working Paper. Available at: https://www.frbsf.org/economic-research/events/2019/november/economics-of-climate-change/files/Paper-6-2019-11-8-Riordan-1PM-2nd-paper.pdf (Accessed on February 2, 2022).

Hong, H., Karolyi, G. A., and Scheinkman, J. A. (2020). Climate finance. Review of Financial Studies, 33: 1011-1023.

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Footnotes

Footnotes
↑1 See the Institutions section in this issue.
↑2 The corporate loan market, and specially the syndicated loans markets, constitutes an ideal laboratory to test hypotheses about the effects of climate change / risk on loan pricing, because banks that are the lead arrangers of syndicated loans are informed and incentivized to monitor, and data are widely available (Delis et al., 2021).

Institutions

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Recent international commitments to climate change

The United Nations (UN hereafter) Climate Change Conference (COP26), which was held in Glasgow (UK), brought together many of the world’s leaders to address concerning issues related to climate change. The headline decision of COP 26 was the Glasgow Climate Pact, an initiative of the UK COP Presidency to capture progress beyond the formal agenda. The Intergovernmental Panel on Climate Change (IPCC) released a report in 2018 that identified that global emissions would need to reduce to zero level by at least 2050 to retain a ‘high-confidence’ level to limit the rise of temperatures to sustainable levels (Masson-Delmotte et al., 2018). The US Treasury Secretary Janet Yellen stated that “rising to this challenge will require the wholesale transformation of our carbon-intensive economies” and that “addressing climate change is the greatest economic opportunity of our time.” (COP26, 2021; Depledge et al., 2022).[1]The World Economic Forum and PwC released jointly the Harnessing Technology for the Global Goals report that identified the significant role that digital technology can play in improving resilience … Continue reading

On the heels of the COP26 Finance Day, the banking industry leaders also met in Glasgow to discuss the leadership role of the banking sector toward net-zero emissions.UN-convened Net-Zero Banking Alliance also committed to coordinating climate actions for financial institutions and aligning their lending and investments portfolios with zero-net emissions by 2050. At the time of writing this note, the Alliance brings together around 100 banks worldwide, representing over 40% of global banking assets. The Alliance acknowledges the crucial role of banks in supporting the transition of the real sector to a greener economy (see Beyene et al., this issue).

The European Commission’s sustainable finance strategy

The High-Level Expert Group on sustainable finance was created in 2016 and included members from the civil society, the financial sector, and the Academia from international institutions.[2]The European Commission defines sustainable finance as the process of dully taking environmental and social contemplations into account when making long-term decisions in sustainable activities … Continue reading Notably, the 2018 group’s final report established the pillars for the Action Plan on Financing Sustainable Growth, which is intended to develop the European Union’s sustainable finance strategy and to incorporate environmental, social, and governance (ESG) considerations into the European financial system (European Commission, 2019, González-Martínez, 2021). The Taxonomy Regulation (Regulation (EU) 2020/852 of June 2020) is the cornerstone of the whole Action Plan since it establishes the classification system for the ‘sustainable’ economic activities.[3]See also Regulation (EU) 2019/2088 and Regulation (EU) 2019/2089.[4]In this regard, the European Commission introduced two supplements. First, the Commission Delegated Regulation (EU) 2021/2139 supplements Regulation 2020/852 by establishing the technical screening … Continue reading Interestingly, the EU Ecolabel for retail financial products is dedicated to expressing investors’ preferences regarding sustainability and the more straightforward access to sustainable products.

Disclosures

The Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TCFD), which provides recommendations for assessing and reporting their climate-related strategy.[5]Disclosures of the financial impacts of climate-related and environmental risks are crucial for achieving the transparency necessary to preserve market discipline. In other words, promoting peer … Continue reading In particular, the final report makes sector-specific recommendations on how companies should disclose climate-related financial risks to inform better their investors, lenders, and insurers (Campiglio, 2016; Campiglio et al., 2018). Notably, the PCAF Global Greenhouse Gas Accounting and reporting Standard for the Financial industry offers detailed statistics on measures and disclose emissions for specific assets. The Science Based Target initiative (SBTi) published the Financial Sector Science-Based Targets Guidance which enables companies to set emissions reductions targets according to the foremost climate science (SBTi, 2021).

The European Commission adopted in April 2021 a proposal for Corporate Sustainability Reporting Directive (CSRD) that introduces stricter reporting requirements and widens the scope of applicability with respect to the existing non-financial reporting directive (NFRD). Furthermore, Regulation (EU) 2019/2088 will apply from March 2021. Regarding the development of a European Union Green Bond Standard, in early July 2021 the European Commission presented its proposal based on a voluntary framework that remarks transparency, the need for external review, and the European Securities and Markets Authority should supervise it.

Remarkably, integrating ESG risks into the Supervisory Review and Evaluation Process (SREP) performed under the Pillar 2 as not exempt from difficulties. However, the EC has considered these recommendations in developing the EU Banking Package that finalises the implementation of Basel III in Europe. Formally, Pillar 3 disclosure requirements are expanded from applying to large, listed institutions to all in the scope of the CRR (EBA, 2021; Marullo Reedtz, this issue). Importantly, as a part of the Pillar 3 disclosure and the NFRD, the Green Asset Ratio measures the “greenness” of the bank’s balance sheet, and it will allow investors and regulators to evaluate and foster new legislation toward green finance. Recently, in January 2022 the European Banking Authority (EBA) released the final draft of the Implementing Technical Standards (ITS) on Pillar 3 disclosures on ESG risks (Mikkelsen et al., this issue).

The role of central banks

Globally, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) in December 2017 was aimed at defining and promoting good practices, conducting analysis, fomenting climate risk management in the financial sector, and mobilising funds needed for a transition towards a sustainable economy (NGFS, 2021). In Europe, the national central banks incorporate climate-related questions intro their actions. Furthermore, central banks not belonging to the Eurosystem are even introducing environmental questions into their design of the monetary policy. Central banks have begun integrating sustainable and responsible investment (SRI) principles into their portfolio management (NGFS, 2019, 2020). Outstandingly, the European Central Bank is progressing in evaluating and limiting the potential aftermaths of climate change (ECB, 2021a,b; Reghezza et al., 2021).The European Central Banks is advancing on preparing and executing the ECB Thematic Review on Climate-Related and Environmental (C&E) Risks and the ECB Climate Stress tests that include transition and physical risks in a horizon of 30 years. Accordingly, the SSM included climate-related risks in its 2019 and 2020 roadmaps that draw up supervisory expectations for relevant banks (Alonso and Marqués, 2019; Gonzalez and Núñez, 2020, 2021).

References

Alonso, A., and Marques, J.M. (2019). Financial innovation for a sustainable economy. Occasional paper No. 1916. Bank of Spain. Available at: https://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosOcasionales/19/Files/do1916e.pdf (Accessed on April 18, 2022).

Beyene, W., Delis, M., and Ongena, S. (2021). Disclosure of banks fossil exposures. European Economy – Banks, Regulation and the real Sector, this issue.

Campiglio, E. (2016). Beyond carbon pricing: The role of banking and monetary policies in financing the transition to a low-carbon economy, Ecological Economics 121, 220-230. DOI: https://doi.org/10.1016/j.ecolecon.2015.03.020

Campiglio, E., Dafermos, Y., Monnin, P., Ryan-Collins, J., Schotten, G., and Tanaka, M. (2018). Climate change challenges for central banks and financial regulators. Nature Climate Change 8, 462-468. DOI: https://doi.org/10.1038/s41558-018-0175-0

COP26. (2021). COP26 Goals. Available at: https://ukcop26.org/cop26-goals. (Accessed on April 18, 2022).

Depledge, J., Saldivia, M., and Peñasco, C. (2022). Glass half full or glass half empty?: The 2021 Glasgow Climate Conference, Climate Policy, 22, 147-157, DOI: 10.1080/14693062.2022.2038482

European Central Bank (2020). ECB report on institutions’ climate-related and environmental risk disclosures. Available at: https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.ecbreportinstitutionsclimaterelatedenvironmentalriskdisclosures202011~e8e2ad20f6.en.pdf (Accessed on April 18, 2022).

European Central Bank (2021a). Climate-related risk and financial stability. ECB/ESRB Project Team on climate risk monitoring. Available at: https://www.ecb.europa.eu/pub/pdf/other/ecb.climateriskfinancialstability202107~87822fae81.en.pdf (Accessed on April 18, 2022).

European Central Bank (2021b). Detailed roadmap of climate change-related actions. Available at: https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210708_1_annex~f84ab35968.en.pdf (Accessed on April 18, 2022).

European Commission (2019). Guidelines on reporting climate-related information. Available at: https://ec.europa.eu/finance/docs/policy/190618-climate-related-information-reporting-guidelines_en.pdf (Accessed on April 18, 2022).

González-Martínez, C.I. (2021). Overview of global and European institutional sustainable finance initiatives. Bank of Spain. Available at: https://www.bde.es/f/webbde/SES/Secciones/Publicaciones/InformesBoletinesRevistas/ArticulosAnaliticos/21/T3/Files/be2103-art30e.pdf (Accessed on April 18, 2022).

González, C. I., and S. Núñez (2020). Cambio climático y sistema financiero: una necesaria mirada al futuro. Papeles de Economía Española No 163, pp. 130-145. Available at: https://www.funcas.es/articulos/cambio-climatico-y-sistema-financiero-una-necesaria-mirada-al-futuro-transicion-hacia-una-economia-baja-en-carbono-en-espana-2019-n-163/ (Accessed on April 18, 2022).

González, C. I., and S. Núñez (2021). Markets, financial institutions and central banks in the face of climate change: challenges and opportunities. Occasional Paper No. 2126. Bank of Spain. Available at: https://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosOcasionales/21/Files/do2126e.pdf (Accessed on April 18, 2022).

Marullo Reedtz, P. (2021). Financing the environmental transition in Europe. European Economy – Banks, Regulation and the real Sector, this issue.

Masson-Delmotte, V., Zhai, P., Pörtner, H. O., Roberts, D., Skea, J., Shukla, P. R.,. and Waterfield, T. (2018). Global warming of 1.5C. An IPCC Special Report on the impacts of global warming of, 1(5).

Mikkelsen, D., Viscardi, S., Montes, M., and De Amicis, F.P. (2021). Climate change regulation and supervision in Europe and implications for commercial banks. European Economy – Banks, Regulation and the real Sector, this issue.

NGFS (2019). First comprehensive report. A call for action, April.

NGFS (2021). Annual Report 2020, April.

Reghezza, A., Altunbas, Y., Marques-Ibañez, D., Rodriguez d’Acri, C., and Spaggiari, M. (2021). Do banks fuel climate change? ECB Working Paper Series No. 2550. Available at: https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2550~24c25d5791.en.pdf (Accessed on April 18, 2022).

Science-Based Targets initiative (SBTi). 2021. Financial Sector Science-Based Targets Guidance Pilot Version 1.1, Science-Based Targets initiative (SBTi), Report. Available at: https://sciencebasedtargets.org/resources/files/Financial-Sector-Science-Based-Targets-Guidance-Pilot-Version.pdf (Accessed on April 18, 2022).

World Economic Forum & PwC (2021), Harnessing Technology for the Global Goals: A framework for government action, Accessed on 31st October 2021. Accessed at: https://assets.2030vision.com/files/resources/wef-harnessing-technology-for-the-global-goals-2021.pdf?470b76352b (Accessed on April 18, 2022).

Legislation cited

Commission Delegated Regulation (EU) 2021/2139 of 4 June 2021 supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by establishing the technical screening criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change mitigation or climate change adaptation and for determining whether that economic activity causes no significant harm to any of the other environmental objectives. Available at: http://data.europa.eu/eli/reg_del/2021/2139/oj (Accessed on April 18, 2022).

Commission Delegated Regulation (EU) 2021/2178 of 6 July 2021 supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU concerning environmentally sustainable economic activities, and specifying the methodology to comply with that disclosure obligation. Available at: http://data.europa.eu/eli/reg_del/2021/2178/oj (Accessed on April 18, 2022).

Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups Text. Available at: https://eur-lex.europa.eu/eli/dir/2014/95/oj (Accessed on April 18, 2022).

European Commission (2019). Communication from the Commission — Guidelines on non-financial reporting: Supplement on reporting climate-related information (2019/C 209/01). Available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52019XC0620%2801%29 (Accessed on April 18, 2022).

European Commission (2018). Communication from the European Parliament, the European Council, the Council, the European Central Bank, The European Economic and Social Committee of the Regions. Action Plan: Financing Sustainable Growth (COM/2018/097 final). Available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52018DC0097 (Accessed on April 18, 2022).

Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (Text with EEA relevance) Available at: https://eur-lex.europa.eu/eli/reg/2020/852/oj (Accessed on April 18, 2022).

Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector (PE/87/2019/REV/1). Available at: https://eur-lex.europa.eu/eli/reg/2019/2088/oj (Accessed on April 18, 2022).

Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks (PE/90/2019/REV/1). Available at: https://eur-lex.europa.eu/eli/reg/2019/2089/oj (Accessed on April 18, 2022).

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 Text with EEA relevance. Available at: http://data.europa.eu/eli/reg/2013/575/oj (Accessed on April 18, 2022).

Footnotes

Footnotes
↑1 The World Economic Forum and PwC released jointly the Harnessing Technology for the Global Goals report that identified the significant role that digital technology can play in improving resilience to global warming related, natural hazards, reducing emissions, and improving the ability for humans to take the necessary steps to achieve the zero net target (World Economic Forum & PwC, 2021).
↑2 The European Commission defines sustainable finance as the process of dully taking environmental and social contemplations into account when making long-term decisions in sustainable activities (European Commission, 2018). Accordingly, the so-called Capital Markets Union is a priority, and a key step for implementing the Paris Agreement and the European Union’s sustainable agenda.
↑3 See also Regulation (EU) 2019/2088 and Regulation (EU) 2019/2089.
↑4 In this regard, the European Commission introduced two supplements. First, the Commission Delegated Regulation (EU) 2021/2139 supplements Regulation 2020/852 by establishing the technical screening criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change mitigation or climate change adaptation and for determining whether that economic activity causes no significant harm to any of the other environmental objectives. Second, Commission Delegated Regulation (EU) 2021/2178 supplements regulation 2020/852 by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU, the methodology to comply with that disclosure obligation.
↑5 Disclosures of the financial impacts of climate-related and environmental risks are crucial for achieving the transparency necessary to preserve market discipline. In other words, promoting peer pressure incentivizes companies to manage and diminish their individual risk (ECB, 2020).

Numbers

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A sector-based classification approach

Figure 1. European banks’ exposure towards climate-policy-relevant sectors.

Figure 1

Notes: Own elaboration based on the classification of climate-policy-relevant sectors (CPRS) proposed by Battiston et al. (2017)[1]Battiston, S., Mandel, A., Monasterolo, Schütze, F and Visentin, G. (2017). A climate stress-test of the financial system. Nature Climate Change 7: 283-288. DOI: https://doi.org/10.1038/nclimate3255 applied to EU banks’ exposures provided by EBA. The CPRS consists of 8 categories, with different incidence in each sector: 1. Fossil fuel, 2. Utility, 3. Energy-intensive, 4. Buildings, 5. Transportation, 6. Agriculture, 7. Finance and 8. Others. Exposures to categories 1 to 6 are defined as those that may be affected by climate transition risks. The total value of expositions is of 2,346.53 billion of euros.

 

 

 

Figure 2: European banks’ exposure towards climate-policy-relevant sectors by category of climate transition risk.

Figure 2

Notes: Based on the classification of climate-policy-relevant sectors (CPRS) proposed by Battiston et al. (2017)[2]Battiston, S., Mandel, A., Monasterolo, Schütze, F and Visentin, G. (2017). A climate stress-test of the financial system. Nature Climate Change 7: 283-288. DOI: https://doi.org/10.1038/nclimate3255 applied to EU banks’ exposures provided by EBA. The CPRS consists of 8 categories, with different incidence in each sector: 1. Fossil fuel, 2. Utility, 3. Energy-intensive, 4. Buildings, 5. Transportation, 6. Agriculture, 7. Finance and 8. Others. Exposures to categories 1 to 6 are defined as those that may be affected by climate transition risks. The total value of expositions is of 2,346.53 billion of euros.

 

 

 

A greenhouse gas (GHG) emission-based classification approach

Figure 3: European banks’ exposure according to greenhouse gas emission intensity

Figure 3

Notes: Based on EBA. Greenhouse emission intensity buckets applied to EU banks’ exposures provided by EBA. Buckets are defined based on percentiles of the distribution of greenhouse gas, produced by Trucost (S&P Global) https://www.trucost.com (see the table below). The total value of expositions is of 2,346.53 billion of euros.

GHG intensity

 

 

 

Figure 4: European banks’ exposure according to greenhouse gas emission intensity and sector.

Figure 4

Notes: Based on EBA.

 

 

 

A scenario analysis

Figure 5: GDP evolution under different climate scenarios.

Figure 5

Notes: Based on the EBA. The two scenarios represent the difference with respect to orderly transition, and they are built using the parameters sourced from the new ECB climate risk stress test framework, which includes the impact of both the transition and physical risks. The ‘disorderly’ scenario is associated with relatively high costs from a delayed/ineffective transition, and the ‘hot house world’ scenario is when no polices are implemented and natural catastrophes might occur.

 

 

 

Figure 6: Changes in firm-level probability of default with respect to the orderly transition scenario (2020 to 2050).

Figure 6

Notes: Based on EBA. Full bars represent the average increase in the probability of default across firms; dotted bars the increase for firms that are more vulnerable to physical risk. The two scenarios represent the difference with respect to orderly transition, and they are built using the parameters sourced from the new ECB climate risk stress test framework, which includes the impact of both the transition and physical risks. The ‘disorderly’ scenario is associated with relatively high costs from a delayed/ineffective transition, and the ‘hot house world’ scenario is when no polices are implemented and natural catastrophes might occur.

 

 

 

Figure 7: Green asset ratio.

Figure 7

Notes: Based on the EBA. The green asset ratio is constructed for each bank by dividing the green exposure – available only for a subset of exposures – by the total original exposure. The green amount is constructed using either bank’s self-reported data or TAC estimates.

Footnotes

Footnotes
↑1, ↑2 Battiston, S., Mandel, A., Monasterolo, Schütze, F and Visentin, G. (2017). A climate stress-test of the financial system. Nature Climate Change 7: 283-288. DOI: https://doi.org/10.1038/nclimate3255