5.5 Internal capital adequacy assessment process and internal liquidity adequacy assessment process

Institutions should incorporate material ESG risks and their impacts on financial risk catego-ries into their ICAAP to assess, and maintain on an ongoing basis, the amounts, types and distribution of internal capital that they consider adequate to cover the nature and level of ESG risks, taking into account the short, medium and long term.

When institutions take into account longer time horizons for the coverage of ESG risks, these time horizons should be used as a source of information to ensure a sufficient understanding of the potential implications of ESG risks for capital planning within the regular ICAAP time horizons. The time horizons considered for the determination of adequate internal capital to cover ESG risks should be consistent with the time horizons used as part of the institutions’ overall ICAAP. The ICAAP should be sufficiently forward-looking and where an institution as-sesses that risks should not be covered by capital but be mitigated through other tools or actions, it should be explained.

Institutions should use insights gained from their risk assessment methodologies, including those referred to in Section 4.2, to identify and measure internal capital needs for exposures or portfolios assessed as more vulnerable to ESG risks, taking into account the differing levels of availability and maturity of quantification methodologies for environmental risks compared to social and governance risks.

With regard to environmental risks, institutions should include in their ICAAP a forward-look-ing view of their capital adequacy under an adverse scenario that includes specific environ-mental risks elements. In addition, institutions should specify any changes to the institution’s business plan or other measures derived from climate or environmental risks stress testing and/or reverse stress testing, in line with paragraph 90 of EBA Stress Testing Guidelines¹⁵ .

Institutions should incorporate material environmental risks and their impacts on liquidity in their internal liquidity adequacy assessment process (ILAAP) over appropriate time horizons within the scope of the ILAAP coverage.

15 EBA Guidelines on institutions stress testing (EBA/GL/2018/04) 31

Institutions should include in their ICAAP and ILAAP frameworks a description of the risk ap-petite, thresholds and limits set for, respectively, material ESG risks and material environmen-tal risks and their impacts on their solvency or liquidity, as well as the process applied to keep-ing these thresholds and limits up to date. Institutions should provide sufficient contextual information to understand their analysis of the capital and liquidity implications of, respec-tively, ESG and environmental risks, including by providing clarity on the methodologies used and underlying assumptions.

When integrating ESG risks into their ICAAP and environmental risks in their ILAAP, the com-plexity of the processes and the degree of sophistication of the methodologies used by insti-tutions should take into account their size and complexity and the results of their materiality assessment.