Climate and nature will be integrated into banking supervision in OIC markets faster than most banks expect

WWF have released their latest update to their evaluation of central bank and financial supervisors’ policy responses on sustainability, climate and nature issues. Among the six OIC countries covered (Indonesia, Malaysia, Morocco, Saudi Arabia, Türkiye and the UAE), there was wide variability in the ways that sustainability, climate and nature risks are being addressed. Policy responses among OIC countries and across the 47 countries covered showed no correlation with countries’ income levels.

Malaysia had the fullest policy response to climate and nature risks, and together with Indonesia was cited specifically for the guides they provided for financing high-risk sectors, which were unique among jurisdictions covered. Across the sample of countries evaluated (not ranked, because each indicator was included on an unweighted basis), policy follow-through in banking supervision for countries with Net Zero policies was limited, particularly among high-income countries.

WWF noted that 20 of the 37 jurisdictions covered by national Net Zero targets had fewer than 50% of the climate policies related to banking supervision in place. Among OIC countries covered, only Malaysia exceeded the 50% level. With national Net Zero targets becoming more commonplace only after COP 26, and many OIC markets adopting their own targets just the following year, there is some justification for why banking supervision policies may not yet have gathered pace.

Yet it is vitally important that the financial sector in every country plays a role in sustainability, through the climate transition and in support of nature recovery and restoration. WWF recommends that stakeholders in each country add to their Net Zero target a ‘biodiversity recovery by 2050 target’ as well, noting that “people and nature must be allies for the 1.5˚ C pathway”.

Although WWF’s Sustainable Financial Regulations (SUSREG) assessment focuses on the roles of banking and insurance supervisors as well as central banks, there are key implications for banks as well across OIC markets. Most important is the speed that policy moves between jurisdictions as they share best practice through networks like the NGFS. Malaysia has become a leader in part through its adoption of policy using resources gained through its participation in the NGFS, as well as from other global sources including the Basel Committee’s guidelines on climate-related risk management and supervision.

It hasn’t copied all from international sources, and some developments in both Malaysia and Indonesia have benefited from the collaboration of regulators through the ASEAN Capital Markets Forum and ASEAN Taxonomy Board. These have added distinct regionally specific context to the policies adopted to guide bank supervision, in particular.

And at a national level there has been a unique contribution into the process by Islamic banks (with some analogous developments occurring within the takaful sector). Malaysia was commended for the development of sectoral guides for high-risk sectors, whose creation originated from the work of the VBI Community of Practitioners but useful for all banks. Efforts that began at least five years ago with the VBI Assessment Framework and other initiatives that preceded it have quickly supported Malaysia’s recognition on climate-related banking supervision policies.

All these banking supervision policies need to become embedded within banks, and that isn’t something that happens overnight. Banks operating in markets that have fewer climate or nature-oriented supervision policies should not take that as a signal to ignore development of their capacity. To the contrary, it should demonstrate a huge opportunity for them to get ahead of their peers.

The lack of a regulatory lead on evaluating climate or nature risks, or in supporting customers’ transition plans or for banks to look at developing their own transition plans, represents a quickly closing window for gaining a competitive upper hand. With increased policy coordination to tackle global problems such as climate and nature loss, policies are able to spread quickly to markets where they have not yet been adopted.

Eventually banks will have their climate and nature priorities — or at least a minimum bar — set for them in regulation. In the meantime, if banks start to work proactively to identify the issues that are more relevant to them, and then implement diligently to build their own capacity, this can prepare them for future regulation while also producing competitive advantage in the meantime to better understand risks and opportunities relating to climate change and natural capital overall.

Want to learn more about responsible finance in Islamic markets & Islamic finance? Subscribe to RFI’s free email newsletter today!