Thematic review: Plenty of room for development in climate and environmental risk management by credit institutions under direct FIN-FSA supervision
In May–September 2023, the Financial Supervisory Authority (FIN-FSA) conducted a thematic review to examine the present state of the management of climate and environmental risks and related development plans in seven credit institutions under the FIN-FSA's direct supervision. The thematic review was based on a survey comprising four areas of climate and environmental risk management:
- materiality assessment
- impacts on the credit institution’s business model and strategy
- impacts on governance and risk appetite, and
- impacts on risk management with respect to different risk areas, focusing on credit, business model and operational risks.
As part of the thematic review, the FIN-FSA also reviewed the disclosures on climate and environmental risks by these credit institutions as at end-2022.
Significance of climate and environmental risks in credit institutions’ risk management is constantly rising
Climate change and environmental degradation result in significant changes that also affect the Finnish financial system and real economy as well as the profitability and capital adequacy of credit institutions. Therefore, credit institutions should identify growing climate and environmental risks, and prepare for their impacts in their risk management. The European Central Bank (ECB) published a Guide on climate-related and environmental risks in 2020, and the European Banking Authority (EBA) is preparing more detailed regulation for credit institutions on the management of climate and environmental risks and their treatment in prudential framework. The Corporate Sustainability Reporting Directive (CSRD), which entered into force in January 2023, and related reporting standards will significantly increase the amount of information to be disclosed on climate and environmental risks – already starting from the end-2024 reference date for some credit institutions.
The FIN-FSA's thematic review built on the supervisory expectations stated in the ECB Guide for climate and environmental risks, as applicable. The Guide recommends that national supervisory authorities apply the expectations of the Guide on the basis of the proportionality principle, taking into account the nature, scale and complexity of the activities of each credit institution. Even a small credit institution may be vulnerable to the impacts of climate change and environmental degradation, in particular if its activities focus on markets, sectors or geographical areas are exposed to material physical and transition risks.
Physical risk factors include increasing floods and storms as well as heat and drought, causing forest fires among other things, but also longer-term changes in natural conditions. Transition risks are caused by the evolution of the operating environment in the context of adjustment towards a lower-emission economy. These may be related, for example, to political decision making and regulation or changes in market behaviour.
In the thematic review, plenty of room for development was identified in the assessment of materiality, risk management and disclosures.
1. Materiality assessment
A systematic and comprehensive assessment of the materiality of climate and environmental risks is important because it lays the foundation for adequate and proportionate risk management. According to the responses, most credit institutions have conducted qualitative materiality assessment at least for some risk categories. Some of the credit institutions have also conducted quantitative assessment of market risk associated with investments, involving the consideration of certain climate and environmental factors. Nevertheless, ample room for development was identified regarding the materiality assessment.
- In many credit institutions, the assessment still focused on a corporate responsibility point of view emphasising the direct environmental impacts of the credit institution’s own activities and investments. Potential physical and transition risks were not yet assessed comprehensively with a view to the credit institution’s business and risk profile.
- Only some of the credit institutions’ assessments covered available quantitative data, such as the location of real estate assets or real estate collateral in flood risk areas and the concentration of exposures in emission-intensive sectors.
- The assessments did not separately consider a short, medium and long-term horizon.
- Most of the credit institutions had failed to document the assessment of materiality comprehensively, and there was also room for development in reporting to the management.
2. Business model and strategy
The credit institutions participating in the thematic review do not yet consider, in much depth, risks related to climate change and environmental degradation in the context of their strategy process and strategic decision making. For the time being, result or risk indicators related to climate risks were few in number. The monitoring indicators are mostly concerned with the sustainability impacts of the credit institution's own activities, such as carbon footprint.
3. Governance and risk appetite
Based on the thematic review, credit institutions do not pay comprehensive attention to climate and environmental risks in their governance systems and risk appetite statements. Almost all of the credit institutions had shortcomings for example in the following areas:
- There was no regular reporting on climate and environmental risks to senior management.
- The members of the board of directors or its committees did not have assigned responsibilities for climate-related risks, and the expertise of the board in respect of the abovementioned risks had not been evaluated.
- The tasks and responsibilities of the three lines of defence in the management of climate and environmental risks had not been defined.
4. Risk management
The credit institutions included in the thematic review had not yet integrated the impacts of climate and environmental risks into their risk management comprehensively in terms of different risk categories, but some progress could be identified.
- As regards credit risk, the integration of climate and environmental risks in credit guidelines and credit-granting processes in particular had been launched in most of the credit institutions. Among other things, some of the credit institutions require a review of the customer's exposure to climate and environmental risks in the context of credit granting or customer onboarding.
- As regards operational risks, the credit institutions acknowledged current physical risks, such as floods and storms, in their continuity plans. However, they did not yet consider the long-horizon impacts of climate changes in their operational risk assessment
- As regards reputational risks, some of the credit institutions identified risks potentially associated with, for example, sectors, companies or investments with environmentally adverse impacts, but they did not yet monitor and assess the evolution of these risks nor have policies or guidelines to manage them.
5. Review of disclosures
As part of the thematic review, the FIN-FSA studied the extent to which the credit institutions had disclosed information related to climate and environmental risks and management thereof in their management reports and sustainability reports for 2022. There were major differences across the credit institutions, and a lot of room for development was identified.
6. Development plans for sustainability reporting
Based on the responses to the thematic review, all credit institutions that will report the information under the CSRD as from end-2024 have launched a reporting project or some other development project at the latest in the first half of 2023. However, the schedules of some of the credit institutions look challenging.
The FIN-FSA requires credit institutions under its direct supervision to develop the management and reporting of climate and environmental risks.
The FIN-FSA recommends that, in the management of climate and environmental risks, credit institutions under its direct supervision comply with the EBA Guidelines referred to in the appendix. The FIN-FSA will take the expectations of the ECB supervisory guide into account, as applicable, in the supervision of the abovementioned credit institutions. Based on the results of the thematic review, the FIN-FSA requires the abovementioned credit institutions prepare a comprehensive and documented assessment of the materiality of climate and environmental risk as well as a plan to develop the management of these risks. The FIN-FSA will reassess the management of climate and environmental risks by credit institutions under its direct supervision once the detailed guidelines being prepared by the EBA have entered into force. The FIN-FSA will also monitor the credit institutions’ progress in the development of sustainability reporting.
For further information, please contact
Jaana Ladvelin, Chief Specialist, tel. +358 9 183 5313 or jaana.ladvelin(at)finanssivalvonta.fi
- ECB Guide on climate-related and environmental risks
- EBA Guidelines on loan origination and monitoring (EBA/GL/2020/06)
- EBA Guidelines on internal governance (EBA/GL/2021/05)
- EBA Guidelines on the assessment of the suitability of members of the management body and key function holders (EBA/GL/2021/06)
- EBA Guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) and supervisory stress testing (EBA/GL/2022/03)
- EBA Guidelines on sound remuneration policies under Directive 2013/36/EU (EBA/GL/2021/04)
- Corporate Sustainability Reporting Directive (CSRD, (EU) 2022/2464)
- European Commission website on corporate sustainability reporting
- EBA Roadmap on Sustainable Finance