By Huw Jones

LONDON (Reuters) – Banks in the European Union have swelled their capital buffers and boosted profitability over the past year, but they must not be “overly generous” in paying bonuses and dividends given the risk of abrupt market pullbacks, the bloc’s banking watchdog said on Friday.

The European Banking Authority (EBA) said in its annual risk assessment report that it was also monitoring the exposure of banks to clearing houses in London and that lenders should examine if they are allocating enough capital to cover environment, social and governance (ESG) risks.

“Given the COVID-19-related uncertainties, banks should maintain prudent capital distribution policies,” EBA said in a statement.

EU regulators curbed bank payouts last year as they assessed the impact of COVID-19 lockdowns on the economy but lenders are now catching up.

While aggregate capital levels are good, not all banks are well above minimum requirements, with pandemic fallout cushioned by central bank funding, which has increased significantly in importance for lenders, EBA said.

“Even though supervisory recommendations on capital distribution have expired, banks should not pursue overly generous dividend and share buy-back policies,” EBA said.

Regulators and supervisors should provide clarity on how quickly banks should replenish any buffers that were tapped during the pandemic, EBA said.

The watchdog also published its “transparency exercise” for the year, which provides 10,000 data points on 120 banks in the bloc for analysts to number crunch and make comparisons.

EBA said it was also monitoring the concentration risk from significant exposures that EU banks have to clearing houses in London, equivalent to 9.5% of the total amount of over-the-counter derivatives cleared globally in the second half of last year.

The bloc has said it will extend temporary permission for banks to continue clearing derivatives in London beyond next June and set out incentives for shifting clearing to the EU.

Britain’s departure from the bloc a year ago has increased legal uncertainty, with EU dependence on UK rules for handling clearers in trouble also rising, EBA said.

(Reporting by Huw Jones; Editing by Susan Fenton)