NGFS published a paper on the overview of environmental risk analysis by financial institutions and an occasional paper on the case studies on environmental risk analysis methodologies. These papers provide important references to the tools and methodologies used by financial institutions for measuring exposure to environmental risks and for assessing the financial implications of these risks in a forward-looking manner, including via stress testing and scenario analysis. Both the publications conclude that, to effectively address climate-related and environmental risks, greater collective efforts are urgently needed from regulators, financial institutions, international organizations, third-party vendors, and academic institutions to promote wider adoption of environmental risks analysis in the financial industry.
The overview of environmental risk analysis by financial institutions provides wide-ranging examples of how environmental risks translate into financial risks, along with an in-depth review of the tools and methodologies for environmental risk analysis used by financial institutions, including banks, asset managers, and insurance companies. It also identifies the major barriers to wider adoption of environmental risk analysis by the financial services industry, including the lack of awareness of environmental risks, inadequate data, incomplete methodologies, and limited capacity. The overview outlines six opportunities for mainstreaming environmental risk analysis within the financial sector:
- Enhancing environmental risk analysis awareness—Central banks and financial supervisors should strive to enhance environmental risk analysis awareness among financial institutions by conducting environmental risk analysis and clarifying expectations or standards for financial institutions to implement environmental risk analysis.
- Capacity building—Industry associations, central banks and supervisors, international organizations, nongovernmental organizations, and academic institutions could organize seminars and training activities on environmental risk analysis methodologies, with some results delivered as public goods to the financial industry.
- Supporting demonstration projects—NGFS, international organizations, central banks, and supervisors should consider supporting environmental risk analysis projects in key sectors, such as banking, insurance and asset management, and in key regions exposed to substantial environmental and climate-related risks.
- Disclosing risk exposure and results of environmental risk analysis—A robust and internationally consistent climate and environmental disclosure framework is needed. For countries with more developed environmental risk analysis tools and capacity, central banks and supervisors could encourage financial institutions to disclose their exposures to environmental and climate risks as well as the results of their environmental risk analysis in line with the recommendations of the Task Force on Climate-related Financial Disclosures.
- Developing Key Risk Indicator and statistics—NGFS and relevant international organizations could conduct research while encouraging other market bodies and academic institutions to develop a Key Risk Indicator that facilitates the identification, measurement, and data comparability of environment and climate-related risks.
- Developing a taxonomy of economic activities—NGFS calls on policymakers to bring together the relevant stakeholders and experts to develop and adopt green and brown taxonomies that enhance the transparency around the environment, social, and governance characteristics of the economic activities.
The occasional paper contains a more detailed and in-depth discussion of the tools and methodologies for environmental risk analysis through case studies of more than 30 organizations. The occasional paper aims to inform the financial community of the environmental risk analysis methodologies and inspire interested institutions to further develop and enhance these methodologies. The paper presents a taxonomy of environmental risks, explains how these risks may translate into credit, market, underwriting, and operational risks for financial institutions. The paper also discusses the major gaps between research and application of the environmental risk analysis tools and presents a number of recommendations for stakeholders on ways to promote environmental risk analysis in the financial industry.
Keywords: International, Banking, Insurance, Securities, ESG, Climate Change Risk, Taxonomy, Stress Testing, Environmental Risk Analysis, Credit Risk, Basel, NGFS
Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
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