In 2023, the FIN-FSA carried out thematic reviews of banks and insurance sector institutions under its direct supervision. The reviews focused on the present state of climate and environmental risk management as well as climate risk exposures. It is important in both sectors that both the operators and the supervisor are well aware of the kind of effects climate risks have on the operators and how these risks are managed.

Risks related to climate change are typically divided into physical risks and transition risks. Physical risks comprise the adverse effects of climate warming, such as floods, storms and changing 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.

Significance of climate and environmental risks in banks’ risk management has increased

Banks must identify and manage climate risk in the same way as they identify and manage other risks that they are exposed to in banking operations. Climate change and environmental degradation result in significant changes that also affect the Finnish financial system and real economy as well as banks’ profitability and capital adequacy. Even smaller banks may be vulnerable to the impacts of climate change and environmental degradation, in particular, if their activities focus on markets, sectors or geographical areas exposed to material physical risks and transition risks.

A thematic review was carried out to explore the present state of climate and environmental risks and related development plans in seven banks under the FIN-FSA’s direct supervision. The review built on the supervisory expectations laid out in the ECB’s Guide on climate-related and environmental risk management, as applicable.

The review focused on four areas of climate and environmental risk management:

• materiality assessment
• impacts on the business model and strategy of the credit institution
• impacts on governance and risk appetite
• impacts on risk management with respect to different risk areas, focusing on credit, business model and operational risks.

It was stated in the conclusions of the thematic review that the banks continued to have plenty of room for development in all four areas.

In the same context, a further subject of study was the extent to which the banks had published information in their management reports and sustainability reports for 2022 related to climate and environmental risks and management thereof. There were major differences across the banks, and most banks still have a lot to do on this subject.

Reporting requirements concerning climate and environmental risks are determined in reporting standards related to the Corporate Sustainability Reporting Directive (CSRD). According to the thematic review, banks have begun preparations for the reporting, but the timelines presented by some of them seem challenging.

Based on the results of the thematic review, the FIN-FSA will require that banks under its direct supervision prepare a comprehensive materiality assessment and a plan to develop the management of climate and environmental risks. It is important that banks identify and prepare for the impacts of growing climate and environmental risks in their risk management.

In the insurance sector, regulatory changes introduced sustainability risks into the supervision of investment activities

Uncertainties related to climate change mean higher risks for investors. The mapping and analysis of these risks is not straightforward. Rising prices of emission allowances, structural changes in the economy and steep fluctuations of energy prices create both threats and opportunities. On the other hand, a potential failure or delay of the green transition also has its risks. In particular, long-term investors, including insurance and pension companies, must also assess the potential for the realisation of physical risks related to climate change and their consequences.

The review of the investment assets of Finnish insurance institutions focused solely on transition risks caused by climate change. They are simpler to assess than physical risks due to more straightforward analytical methodologies and better availability of data, but on the other hand, the reliability of the methodology and the predictive power are weaker. The role of transition risks in Finland is more significant than physical risks, which justifies the choice.

The methodology of the analysis is based on analysis by Battiston¹. With his research team, he observed that direct and indirect exposures to so-called climate-policy-relevant sectors represented a significant proportion of the financial sector’s investments, particularly for fund management companies and pension insurance companies. These sectors have particularly large exposures to transition risks associated with climate change.

The methods and forms of sustainability-based investment are still being developed. For the time being, there are no exact specifications. As a main rule, however, it can be stated that the use of sustainability-related information depends on the objective of the investment activities.

One of the most significant findings of the analysis was that, in assessing transitional risks of climate change, the sector- and company-specific differences are quite significant. In particular, there was quite a bit of variation in life and non-life insurance companies’ investment strategies and key sources of risks at the company level. This should be borne in mind when making comparisons between individual companies. The FIN-FSA will utilise the results of the thematic review in focusing the supervision of sustainability risks.

EU-wide climate risk exercise in 2024

The European Commission has requested the European Supervisory Authorities (ESAs) to conduct a climate risk exercise for the financial sector in cooperation with the ECB and the European Systemic Risk Board (ESRB). The exercise will look into the ability of the financial sector to adapt to climate objectives. The review will focus on the impacts of two adverse scenarios, also considering contagion risks and second-round effects.² The exercise will be carried out during 2024, and the report will be published in early 2025.

¹ A climate stress-test of the financial system. Stefano Battiston, Antoine Mandel, Irene Monasterolo, Franziska Schütze and Gabriele Visentin (2017).
² EBA: One-off Fit-for-55 climate risk scenario analysis, https://www.eba.europa.eu/legacy/risk-analysis-and-data/climate-risk-stress-testing-eu-banks/one-fit-55-climate-risk-scenario.