FiW-R-2: Awareness of physical climate risks among financial services | Umweltbundesamt

FiW-R-2: Awareness of the relevance of physical climate risks among financial services providers

Given the reality of climate change, it is enormously important for the stability of the finance system that financial services providers have a realistic perception of the climate risks associated with their business activities. Of the 27 financial services providers – voluntarily filing reports in 2021 within the framework of CDP – only a third submitted a rating of the relevance of climate risks to their activities. Presumably these risks are still being underrated by financial services providers.

Providers of financial services still underrate climate risks

Financial services providers such as banks, savings banks and insurance companies are important players in the transformation process towards a CO2-neutral and climate-resilient economy. Likewise, they play an essential part in implementing the European ‘Green Deal’. They are tasked with facilitating the financing of investments in the implementation of sustainable company objectives regarding climate protection and climate change adaptation. Moreover, they are beholden to improve their recognition of climate-related risks in the financial system and to practise targeted management of such risks, in other words – to take appropriate financial precautions. Furthermore, greater transparency in the financial system is wanted, thus enabling potential investors to take informed decisions.

Financial services providers bear particular responsibility – by practising targeted risk management – to prevent the impacts of climate change affecting the financial markets, thus leading to destabilisation. It is possible for bankers and investors to reduce such risks by systematically taking these issues into account in all aspects of their working processes. They need to be fully aware that – as providers of capital for companies in the real economy which might suffer losses as a result of physical climate risks or even become illiquid – they are themselves vulnerable to such losses.

Since the mid 2010s, there are increasing concerns among the treasuries and central banks of G20 states that both severe climatic changes and an effective climate protection policy have the potential to inflict adverse impacts on the financial market’s stability. Against this background, the FSB (Financial Stability Board) – an international body which works for the G20 – has set up the TCFD (Task Force on Climate-related Financial Disclosures) which is composed of experts from the real economy and the finance industry. This Task Force has explored which type of information is required from companies and to be submitted to players in the financial market, enabling them to carry out climate-related risk assessments for the development of recommendations underpinned by such information.

The TCFD’s recommendations on improved reporting dating back to 2017²¹⁶ have been incorporated into the revised version of the European ‘Corporate Social Responsibility’ Directive (CSR Directive) dating back to 2014. The amended ‘Corporate Sustainability Reporting Directive – CSRD’ dated 2022 now distinctly includes amended non-financial reporting obligations. These amended reporting obligations are expected to make clear in future, how resilient companies are to climate change and to the outcomes of an effective climate protection policy. There is a close connection between these European Directives and the EU Taxonomy Regulation that came into force in 2020. This regulation requires participants in the finance market who offer financial products, to state in their declarations which parts of their portfolio are in conformity with the EU taxonomy regulation. Activities that support the fulfilment of the above-mentioned ‘Green Deal’ objectives, are considered taxonomy-conform.

There are further amendments or extensions to these reporting obligations in terms of the regulations to be launched imminently by the German and European regulatory authorities such as BaFin and EBA. In future, system-relevant banks, for instance, will have to declare the totals of credit exposed to climate risks according to pillar 3 (elevated standards for declaration purposes) of the equity regulations adopted by the Basel Committee on Banking Supervision (Basel III), differentiated by geographical attribution and sector (cf. Indicator IG-R-1).

On the basis of these new datasets yet to be generated, it will be possible in future to make distinctly more valid statements on the risk management practised by financial services providers. Against this background, the indicator illustrated here – in respect of the financial services providers’ awareness of the relevance of physical climate risks – is to be understood as a proxy indicator. It will be imperative to enhance this indicator once data availability is improved. The indicator is based on CDP data (formerly Carbon Disclosure Project). For 20 years companies active in the finance industry and the real economy have voluntarily submitted reports on greenhouse gas emissions -and other impacts from their business activities on the environment – within the CDP framework. Within the CDP-Klima database, the reporting companies state how they rate the physical risks to their business activities.

More than two thirds of the 27 financial services providers – filing reports in 2021 within the framework of CDP-Klima – did not submit a rating of the relevance of physical climate risks. The remaining companies rated these risks as relevant or even highly relevant – none of the companies denied the relevance of these risks directly. It is not unreasonable to assume that the high proportion of respondents who did not submit a relevance rating might be due to uncertainties in assessing these risks or that they failed to address these challenges.

Given the low number of financial services providers who filed reports, it is impossible to regard the evaluation of responses as representative. However, a survey by the Bundesbank and BaFin conducted in April 2022 among 1,300 small and medium-sized banks and savings banks in Germany produced similar outcomes. Climate risks are rated as low to moderate²¹⁷.

The apparent low rating of the relevance of climate risks implies the much greater risk that financial services providers do not take climate risks into account in any systematic way; neither do they adapt their pricing adequately. Consequently, these providers are not likely to supply companies in the real economy – whom they provide with finance – with the necessary incentives to make their own contribution to reducing the material climate risks.

^{216 - TCFD – Task Force on Climate-related Financial Disclosures 2017: Recommendations of the Task Force on Climate-related Financial Disclosures. Final Report. Basel, 66 pp. https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-2017-TCFD-Report-11052018.pdf}

^{217 - Bundesbank & BaFin – Bundesanstalt für Finanzdienstleistungsaufsicht 2022: Ergebnisse des LSI-Stresstests 2022. Unterlagen zur Pressekonferenz am 28. September 2022. 17 pp. https://www.bundesbank.de/de/presse/pressenotizen/ergebnisse-des-lsi-stresstests-2022-897718}