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New EBA report joins ACE in calling for greater integration of ESG in PD modeling

This would enable banks to better account for and manage E&S risks in their portfolios.

This October, the European Banking Authority (EBA) has published a new report that’s certain to cause a stir in the world of sustainable finance. In fact, it’s already been the subject of much interest here at the ACE office – because it agrees with the findings we published in our recent white paper!

With the effects of everything from climate change to inequality taking their toll on societies and economies, it follows that the associated risks are also impacting the financial environment. The new EBA paper reports that the impact of environmental (E) and social (S) risks on traditional financial risk categories means the prudential framework should better account for these risks.

More specifically, the EBA concludes – and indeed recommends – that as more information becomes available on the impact of E and S risks on defaults and loss rates, “institutions should reflect these risks in their PD and LGD estimates through a re-development or recalibration of their rating systems in the long term. This would enable banks to better account for and manage E&S risks in their portfolios.”

Benefits for banks, business, and society

It’s a position that puts the EBA in line with the experts here at ACE, who explored the benefits of more sustainably minded credit-risk modeling in our white paper, The mystery of the missing sustainability factors: Why it is time to integrate ESG into probability of default models. After all, a more sustainable approach to probability of default (PD) analysis isn’t just good news for our planet and the people who call it home…

“There’s evidence to show that, as well as promoting more sustainable business, considering more non-financial factors in PD models is a wise move for banks in terms of helping them manage their own risk,” explains Vincent Pit, Director, ACE Management Consulting (and a co-author of the white paper). “What’s more, it’s a way to gain important reputational advantages in today’s sustainability-conscious market – and it could even pave the way for a meaningful cultural shift in banking culture by encouraging more honesty and openness between institutions and their clients.”

So, if you’re curious to discover more about the short- and long-term positive impacts of embedding ESG in PD models – and to find out how to go about successfully implementing the changes in practice – download the full white paper here.

And don’t hesitate to contact our team to learn more about how ACE’s regulatory and financial expertise can help you identify and implement the right solutions with lasting impact.