6.6 Management of climate risks

Climate change will affect our environment and the economy in the decades to come. Because of climate change, companies have to change and adjust their business models. Changes in the economy and markets are also reflected in financial stability. For this reason, climate change is a topic closely linked to the activities of central banks.

The Bank of Finland pays attention to climate change both in its activities and in the assessment of the risks to the financial sector. The Bank raises awareness and promotes dialogue on sustainable finance and maps expertise in the field. In addition to internal work, the Network for Greening the Financial System (NGFS) plays a key role in the Bank of Finland’s action in climate-related issues.

Carbon-intensive business models entail a significant transition risk

Climate change creates two types of financial stability risks: physical risks resulting from extreme weather events and transition risks caused by exit from carbon-intensive business models.

The financial stability risks caused by climate change can be significant if financial losses increase due to, for example, more frequent and severe extreme weather events. Insurance companies, banks and investors suffer from these losses.

Transition risks will materialise if climate policies, technological innovations or changes in consumer preferences make carbon-intensive business models financially unprofitable. Investors may have to recognise losses on their assets. Transition risks are significant from the perspective of the financial sector as a whole, as not all entities will be able to divest their carbon-intensive investments without incurring losses.

The Bank of Finland participates in the work to strengthen climate risk identification and the role of sustainable finance

Sustainable finance plays a fundamental role in the achievement of energy and climate targets. The Bank of Finland raises awareness and promotes dialogue on sustainable finance and climate risks and cooperates with other authorities and financial market participants in this area.

The Bank also participates in the activities of the Network for Greening the Financial System (NGFS), a global forum formed by central banks and supervisors. Marja Nykänen, the Deputy Governor of the Bank of Finland, is a member of the NGFS Plenary.

The objective of the NGFS is to develop best practices for the identification of risks related to climate change and to enhance the role of green finance. The NGFS network is essential in formulating common definitions and promoting dialogue.

The network has structured its work into three workstreams:

• Microprudential/Supervision
• Macrofinancial
• Scaling up green finance.

In 2019, the NGFS published recommendations for central banks on, for example, the integration of climate risks in financial stability monitoring and own-portfolio management. By complying with the recommendations, central banks can both enhance their role in the greening of the financial system and manage their environment and climate-related risks. After the publication of the recommendations, the network has continued its work in the dedicated workstreams.

In summer 2019, the ‘Macrofinancial’ workstream published its first report on the systemic risks emerging from climate change. The workstream ‘Scaling up green finance’, in turn, published its first report in October 2019. This gives guidance and recommendations for central banks on the integration of sustainability considerations in their investment activities.

The Bank of Finland conducts a dialogue with the financial sector and other key stakeholders on best practices to manage the risks from climate change in the sector. Dialogue is important, as it is very challenging to assess climate risks, and best practices are always the result of joint efforts.