Updating the Magna Carta of supervision: review of the Core Principles for Effective Banking Supervision

25 April 2024

By Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB

Catching up – and looking ahead

Today the Basel Committee on Banking Supervision (BCBS) published an updated version of its Core Principles for Effective Banking Supervision, which were first published in 1997 and last updated in 2012. The Core Principles, as they are commonly known, are one of the most important sets of global supervisory standards, establishing comprehensive requirements for both supervisors and banks. They cover a wide range of supervisory powers, responsibilities and functions as well as a broad spectrum of prudential requirements and risks. The Core Principles are a playbook that governments, regulators and supervisors across the world follow when adopting and assessing their own supervisory rules and regulations. For example, many requirements in the single European rulebook can be traced back to the Core Principles. They also serve as the benchmark for the International Monetary Fund and the World Bank when assessing the effectiveness of banking supervision as part of their Financial Sector Assessment Programmes (FSAPs). FSAPs are a powerful tool for encouraging jurisdictions to improve their supervisory rules and practices in line with the global practices defined in the Core Principles. In fact, the upcoming 2024-25 FSAP of the euro area will be conducted on the basis of the revised Core Principles, which now explicitly acknowledge the existence of supranational supervisory frameworks such as the Single Supervisory Mechanism. Put simply, the Core Principles are the bedrock of effective global banking supervision. And effective, intrusive supervision is more important than ever, as the banking turmoil of March 2023 showed.^[1]

The revisions to the Core Principles published today are the outcome of rich and reasoned discussions among BCBS members and supervisors from jurisdictions across the world, with input from a wide-reaching public consultation. The revisions reflect the lessons learnt over the past decade and take stock of the structural changes that are reshaping the banking system. Three new topics have been explicitly included in the Core Principles: (i) operational resilience, (ii) business model sustainability, and (iii) climate-related financial risks. Their inclusion is proof that there is a global consensus on the relevance of these risks, and broad agreement on the need for action. As these issues are also relevant for European banks, we identified them as supervisory priorities for 2023-25 and have already made great strides in incorporating them into our supervisory rules and practices.

Bolstering operational resilience

Since the Core Principles were last updated more than a decade ago, supervisors have started paying much closer attention to operational resilience. Given the tumultuous events of recent years, we now place greater focus on banks’ ability to withstand pandemics, cyber incidents, technology failures and natural disasters. In this context, the principle on operational risk has been comprehensively strengthened to explicitly cover operational resilience as well. It now includes enhanced requirements covering a wide range of topics, from governance and business continuity planning to third-party dependency management. These revisions are very much in line with the ECB’s own supervisory initiatives in this area. They will make banks around the world more resilient to operational threats, which are unlikely to fade in the future.

Future-proofing bank business models

In today’s macroeconomic landscape, banks cannot afford to rely on weak business models. Making sure banks adopt sound and forward-looking business strategies that allow them to generate sustainable returns over time has been an important part of the ECB’s supervisory focus over the past few years, against a backdrop of low profitability and the challenges posed by the digital transition. The concept of business model sustainability was missing from the previous version of the Core Principles. The revised Core Principles affirm that the assessment of business model sustainability is a key component of effective supervision. Banks will need to implement appropriate internal processes to ensure the sustainability of their business models. Tougher scrutiny of bank business models will help future-proof the banking sector in an uncertain world.

New risk on the block: climate-related financial risks

Last but not least, I welcome the revisions related to climate-related financial risks. Over the past decade, the magnitude, urgency, non-linearity and irreversibility of the threats posed by climate change have become indisputable. Events that were once confined to television screens have now become an all too familiar reality – we have seen forest fires destroy family homes, lost harvests, water shortages even in the winter, unexpected flooding, landscapes changed beyond recognition, a lack of snow, disappearing glaciers, forests decimated by parasites, insurance prices becoming unaffordable… the list goes on. In some corners of the world, the threats have become existential and are already leading to mass migration and armed conflict. Meanwhile, the distributional and social impacts of climate policies are a source of political risk, which further increases uncertainty around the transition path that the economy will take.

Banks are also affected, and that is why supervisors across the world now agree that climate-related physical and transition risk factors can be a source of financial risk for banks and translate into traditional risk categories such as credit, market, operational, liquidity, strategic, reputational and legal risks. Therefore, the Core Principles now provide a definition of climate-related financial risks and explicitly include climate risks among the types of potentially material risks that banks are required to identify, measure, evaluate, monitor, report and control or mitigate. Supervisors, in turn, must consider climate risks in their risk assessment of banks, and have the power to require banks to submit information that allows for the assessment of the materiality of these risks. The revised Core Principles also refer to emerging risks. The BCBS will continue its forward-looking approach to identifying risks and vulnerabilities in the banking system in this regard, which may pave the way for a broader perspective that extends beyond climate risks to also include nature-related risks.

From a European perspective, none of this sounds too novel – banks supervised by the ECB are already subject to the supervisory expectations set out in the 2020 ECB Guide on climate-related and environmental risks. However, it is important to realise that different supervisory authorities around the world are at different stages of the journey towards tackling climate and environmental risks. This is why recognising climate-related financial risks in a set of global standards is such an important step.

The revisions to the Core Principles are just one achievement of the Basel Committee’s broader strategy on climate. The BCBS is committed to addressing climate-related financial risks to the global banking system in a holistic manner across the three pillars of regulation, supervision and disclosure. It set up the Task Force on Climate-related Financial Risks, which I co-chair, back in 2020 and, following an initial stocktake of members’ initiatives related to these risks, published important analytical papers, set out detailed principles for the management and supervision of such risks and clarified how these risks can be captured in the existing Basel framework.^[2] More recently, the Basel Committee conducted a public consultation on a Pillar 3 disclosure framework for climate-related financial risks and published a discussion paper on the use of climate scenario analysis for the management and supervision of climate-related financial risk.^[3] Further work is also under way on the materiality of potential gaps in the Basel framework, transition planning and climate scenario analyses.

A comprehensive update

I have mainly focused on three major areas of change, but the revisions published today include many other important upgrades to the global supervisory toolkit, such as incorporating into the Core Principles a non-risk-based measure to constrain the build-up of leverage in banks and in the banking sector, enabling authorities to require banks to maintain additional capital in a form that can be released when system-wide risk crystallises or dissipates, and strengthening the expectations placed on banks and supervisors for addressing risks from non-bank financial intermediaries. There are many more.

In sum, the revised Core Principles are a major step forward for the safety and soundness of banks across the world. They will make the global banking system better equipped to face today’s challenges and will help supervisory practices keep pace with our rapidly changing world. They are also a testament to global supervisory cooperation and trust among authorities. The Basel Committee has achieved its goal of making the standards fit for purpose amid a banking landscape and global risk environment that have seen considerable change since 2012. In an uncertain world, the revised Core Principles will help us make sure banks are resilient to operational threats, reliant on sustainable business models and responsive to climate-related financial risks.

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