It is important for financial institutions to consider all relevant risks in order to avoid suffering unexpected losses. Such losses could potentially have a negative impact on the stability of the financial system. Against the backdrop of the increasing impact from climate- and environment-related risks in the financial system, financial supervisors need to understand how these risks are taken into account by supervised institutions.
Therefore, with the help of a select group of financial institutions, the NGFS has performed a survey to assess whether a risk differential could be detected between green, non-green and brown financial assets. This survey focuses on the work performed by financial institutions to track specific risk profiles of green, non-green and brown financial assets (loans and bonds), develop specific risk metrics and analyse potential risk differentials. It aims to present a point-in-time snapshot of current practices among financial institutions, based on the information these institutions have obtained up until now.
The striking result from the study was the diversity of methods, results and motivations for whether to undertake a climate- and environment-related risk assessment. Most of the institutions have undertaken an operational commitment towards greening their balance sheets, with 57% of the respondents undertaking commitments that affect their daily operations either by limiting their exposure to brown assets or by setting green or positive-impact targets. However, the survey responses highlight that the underlying justification is not based on an attested financial risk differential between green and brown assets but rather on a more diffuse perception of risks. Most banks tend to consider their actions to be part of their corporate social responsibility or mitigation measures for reputational, business model or legal risks.
Backward-looking studies on a potential risk differential have only been performed by five respondents. Another three respondents (banks) indicated that they conducted backward-looking analysis with ESG or energy rating of housing loans, but not strictly using green or brown criteria. In both cases,they failed to reach strong conclusions on a risk differential between green and brown assets. These studies have been limited to sub-sectors and performed on a project-basis rather than at counterparty level. Overall, it appears that it is only possible to track the risk profile of green, non-green and brown assets in very few jurisdictions. An important reason for this is that the prerequisites, e.g. a clear taxonomy and available granular data, are not yet in place in most jurisdictions. These results illustrate the challenges for banks and insurance companies to assess their exposure in the absence of common classifications and the inherent limits of backward-looking analysis in a rapidly developing area.