The European Banking Authority (EBA) has published an opinion setting out how prudential supervisors should consider money laundering and terrorist financing (ML/TF) risks in the context of the Supervisory Review and Evaluation Process (SREP). This opinion forms part of the EBA’s ongoing work to strengthen the fight against money laundering and terrorist financing in Europe.

Money laundering and terrorist financing can have a significant, adverse impact on an institution’s soundness and viability. It can also have an impact on the stability and integrity of the financial system in which an institution operates. This is why prudential supervisors need to develop a sufficient understanding of ML/TF risks to enable them to identify ML/TF risks and prudential concerns. ML/TF risks that are particularly relevant to prudential supervisors include those that are indicative of broader deficiencies in the internal governance or internal controls framework, such as ICT-related weaknesses, that criminals can use.

The EBA says it expects prudential supervisors to cooperate effectively and in a timely manner with AML/CFT supervisors to exchange information on ML/TF risks and to assess the implication of those risks for the safety and soundness of the institution they supervise.

This applies to prudential and AML/CFT supervisors that form part of the same competent authority, as it does to prudential and AML/CFT supervisors from different competent authorities and in cross border situations.

The EBA says it will include more detailed guidance on how ML/TF risks should be considered by prudential supervisors as part of their overall SREP assessment in the revised version of the SREP Guidelines that is planned to be published by end December 2021 as set out in the Pillar 2 roadmap.

ESG risks considered

Elsewhere in the past week, the EBA published a discussion paper on environmental, social and governance (ESG) risk management and supervision, aiming to collect feedback for the preparation of its final report on the topic. The discussion paper provides a proposal on how ESG factors and ESG risks could be included in the regulatory and supervisory framework for credit institutions and investment firms. The consultation runs until 3 February 2021.

The main focus of this discussion paper is on the risks to which institutions are exposed via the impact of ESG factors on their counterparties. The paper provides details on the risks stemming from environmental factors, especially climate change, and illustrates ongoing initiatives and progress achieved on this topic over the recent years.

The EBA says it sees the need for enhancing the incorporation of ESG risks into institutions’ business strategies and processes and proportionately incorporating them into their internal governance arrangements. This could be done by evaluating the long-term resilience of institutions’ business models, setting ESG risk-related objectives, engaging with customers and considering the development of sustainable products. Adjusting the business strategy of an institution to incorporate ESG risks as drivers of prudential risks should be considered as a progressive risk management tool to mitigate the potential impact of ESG risks.

Also the existing supervisory review processes might not sufficiently enable supervisors to understand the longer-term impact of ESG risks on future financial positions and related long-term vulnerabilities. Therefore, the discussion paper proposes to enhance the existing supervisory reviews with ESG factors and, more importantly, to introduce a new area of supervisory analysis and evaluation of the long-term resilience of the business model against the time horizon of the relevant public policies or broader transition trends.