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Climate-Related and Environmental Risk Management
Climate-related and environmental risks and the corresponding challenges will have important consequences to various aspects of our lives. Banks are expected to play a major role in for instance financing the transition to a sustainable economy and society.
In November 2020 the European Central Bank (ECB) published supervisory expectations towards the European banking sector: the ECB’s Guide on climate-related and environmental risks provides an overview of 13 recommendations related to Strategy, Governance, Risk management and Disclosures, and banks are expected to fully comply with them. Since then, an increasing number of national regulators and supervisors have also formulated similar expectations.
How does Finalyse address your challenges?
Gap Analysis and implementation plans:
Assessing your current practices, formulating and implementing action plans to remediate any shortcomings identified in the ECB Thematic review.
Materiality assessment and risk identification:
Identifying material risk exposures on different time horizons, and developing climate-related and environmental risk assessment guides / ESG assessment guides.
Proxy methodologies:
Developing and implementing proxy methodologies to close existing data gaps: from purely expert-based proxies to quantitatively well-underpinned methods.
Mapping to traditional prudential risks:
Mapping climate-related and environmental risk drivers (both transition and physical) to traditional prudential risk categories such as credit risk and market risk.
Key Risk Indicators (KRIs):
Translating transition and physical pathways into impacts on risk parameters and KRIs in order to monitor and actively manage the corresponding risks.
Risk appetite and risk profile, ICAAP, capital adequacy and disclosures:
Assessing short, medium and long-term impacts on your risk profile, and integration into your risk appetite, risk profile assessment, Pillar 2 processes and disclosures.
How does it work in practice?
The ECB’s Guide on climate-related and environmental risks, published in November 2020, provides an overview of 13 recommendations related to Strategy, Governance, Risk management and Disclosures, and banks are expected to fully comply with them. Moreover, with the effects of climate change and environmental risks being more visible than ever in our daily lives and the way business is conducted, financial institutions are more inclined to incorporate corresponding objectives and targets into their practices. However, the effective management and measurement of climate-related and environmental risks remain challenging.
Financial institutions can use their well-established risk management practices and frameworks as a starting point, but they need to enhance them to address the climate-related and environmental risks’ unique features such as the combination of short and medium to long-term impacts, nonlinearities, potential tipping points and interconnectedness among various risk sub-types.
Past experiences in scenario analysis and stress testing also provide the financial industry with the opportunity to get a quantitative view on their exposures to the transition to a more sustainable (Paris Agreement aligned or Net Zero) economy and society, as well as on their exposures to physical risks corresponding to climate-related and environmental issues. Moreover, the ECB and an increasing number of national regulators and supervisors request banks to conduct materiality assessments, various risk identification and monitoring exercises, as well as climate risk stress tests on their portfolios while taking into account various transition scenario pathways.
As climate-related and environmental risk measurements (most importantly stress testing and portfolio alignment calculations) entail a significantly longer time horizon and different methodologies compared to traditional practices, many financial institutions will have to redesign – or enhance at least – their existing toolkits in many aspects of their risk management and risk measurement.
Since the publication of the ECB’s Guide on climate-related and environmental risks in November 2020, the ECB has carried out various assessments and inspections on the banks’ preparedness and practices:
- ECB supervisory assessment of climate risks disclosures,
- ECB climate stress test 2022,
- ECB thematic review of climate-related and environmental risks
which led to the overarching conclusions that banks still have a lot to do to ensure full compliance with the ECB’s recommendations.
How can Finalyse help you with climate-related and environmental risk management?
Together with its ‘Climate change risk measurement’ services, Finalyse offers a broad range of solutions in the domain of climate-related and environmental risks:
Key Features
- Benefit from Finalyse’s extensive experience in the area of risk management and risk measurement for financial institutions.
- Ensure compliance with the recommendations set out in the ECB’s Guide on climate-related and environmental risks.
- Understand the climate-related and environmental risk drivers, their transmission into traditional prudential risk categories and their risk management implications.
- Integrate climate-related and environmental risks into financial institutions’ existing toolkits, methodologies and frameworks by using a holistic approach.
- Benefit from Finalyse’s unique approach, tailored to the specific needs and circumstances of each financial institution.
Our subject matter experts
Christophe Caers is a Senior Consultant based in Finalyse Brussels with extensive experience in model development and validation. He has performed full scope validation of several IFRS 9 models from banks operating in the Middle-East. Moreover, Christophe has performed several initial validation exercises on IRB models at a large Belgian bank. Christophe is a certified Financial Risk Manager (FRM).
Alexandre Synadino is a consultant with expertise in risk data analytics, climate risk management and regulatory reporting. He is an active member of the Finalyse Climate Risk Centre. His main area of expertise lies in the research, design and development of physical risk assessments using different tools and methods. Alexandre is involved in the conceptualisation of measurement approaches to cover multiple hazard types, geographies and scenarios to respond to regulatory demands for granular and forward-looking analyses.