Exposure of the borrower to ESG factors

Paragraphs 126 and 146 of the Guidelines on loan origination and monitoring (EBA/GL/2020/06) are related to the assessment of the borrower’s creditworthiness under section 5.2 of those Guidelines. In accordance with these paragraphs, institutions should integrate ESG considerations into the creditworthiness assessment of the borrower at the loan origination process. More precisely, institutions should assess how ESG factors can have an impact on the financial performance of the borrower and whether the borrower takes any adequate measures to mitigate existing or potential detrimental impact of ESG factors on its financial performance. Based on the above, option (a) raised in the question should be considered as the primary perspective to be analysed when the institutions assess the creditworthiness of the borrower. It should also be understood that the borrower’s impact on ESG factors may in turn impact its risk profile and hence its creditworthiness. For example, if the borrower is contributing to climate change by emitting a large volume of greenhouse gasses (the impact of the borrower on ESG factors), this may then increase the transition risk for this borrower and translate into financial risk on its balance sheet (the impact of ESG factors on the borrower).  This interpretation is also in line with the EBA Report on management and supervision of ESG risks for credit institutions and investment firms (EBA/REP/2021/18). More precisely, paragraph 40, 41 and 49 of this report present the concept of the so-called “double materiality”, which are relevant in this context. Based on this interpretation, option (b) raised in the question should also be considered as an input to assess the impact of ESG factors on the borrower and eventually for the assessment of the borrower’s creditworthiness.