3.3 Financial sector plays a significant role in climate change mitigation

The role of access to finance as an enabler of the green transition has become increasingly important in recent years. Central banks and supervisors therefore assess the potential risks that climate change and climate policy may cause to the various financial sector entities. For the assessment of the financial sector's climate risks, the Bank of Finland has developed its analytical capabilities and data and has participated in international cooperation.

Transition towards a carbon neutral economy will require major investments. Financial flows must be steered from unsustainable economic activity towards sustainable activity. The financial sector has an important role as an enabler of the actions required for the mitigation of climate change.

For the financial sector, a cause for concern is not only the transition risks caused by climate policy but also the physical risks caused by the impacts of climate change (in Finnish). A particular cause for concern is the ability of financial sector entities to assess the impact and cost of these long-term risks on their business.

The EU defined sustainable activities and introduced climate risk management into legislation

The COP26 climate summit in late 2021 did not achieve very ambitious progress globally. The EU has nonetheless taken significant steps in promoting its own climate targets.

The EU has stressed, in particular, the transition risks of carbon-intensive companies, especially if they do not have credible plans for reducing emissions.

At the same time, exceptional and extreme weather events, from heat waves to storms and floods, have raised concern over the physical risks caused by climate change.

The EU's framework for sustainable finance made significant progress in 2021. In the taxonomy for sustainable activities (in Finnish), i.e. classification, a political agreement was reached on the climate criteria and reporting under the taxonomy, and their implementation is moving ahead.

In the next phase, the scope of the EU's taxonomy for sustainable finance will be expanded beyond climate, to other environmental considerations.

Sustainable finance and climate risk considerations already have an impact on financial market regulation. For example, the EU Commission's legislative proposals to amend insurance rules and banking rules ensure that these considerations are taken into account.

Central banks and supervisors promoted better reflection of climate risks

Work to enhance the identification and analysis of climate risks is under way in a number of various forums. The risks are reasonable on average, but unevenly distributed.

Some countries and sectors have higher-than average risk concentrations, in which case the total risk may be very significant.

The results show clearly that ambitious mitigation of climate change will reduce the total risks notably.

Year 2021 saw the publication of several key reports. One of them was the updated climate scenarios published by the NGFS climate network of central banks and financial supervisors (Network for Greening the Financial System), which the various entities can use as a basis for their own climate risk assessments. The Bank of Finland participated in this work.

The European Central Bank (ECB) published an EU economy-wide climate stress test. One of the key outcomes of the stress test was that the risks differ considerably across European regions and corporate sectors.

In the European Systemic Risk Board (ESRB) report on the impact of climate risks on financial stability, the findings were very similar to those in the ECB's assessment.

The ECB's Banking Supervision reviewed banks’ approaches to manage climate risks. The results show that none of the institutions are close to fully aligning their practices with the supervisory expectations, but some have already taken considerable steps.

The Bank of Finland continued work to identify domestic financial sector climate risks

In 2021, the Bank of Finland contributed actively in the development of sustainable finance by issuing opinions on the EU’s sustainable finance strategy (in Finnish), sustainable finance taxonomy (in Finnish) and the European green bond standard (in Finnish).

The Bank of Finland published an article on the impact of coastal flood risks on property used as collateral for bank loans. The article shows that the risks are reasonable overall but very unevenly distributed along the coastal areas.

The Bank of Finland also launched an analysis on the financial sector's transition risks. This work deepens our previous analysis on the financial sector's transition risks.

In addition, the Bank of Finland continued work on the identification of data needs (in Finnish) on the development of new indicators.

In international forums, for example in the NGFS and in the committee of European central banks and statistical authorities CMFB (Committee on Monetary, Financial and Balance on Payments Statistics), the better and more extensive availability of relevant data was actively promoted. Those conducting climate risk analyses should be better informed of all the statistical data sources available, and the data should be more granular and forward-looking.

In early 2021, the Bank of Finland launched a project on measuring the carbon footprint of loans to domestic non-financial corporations (NFC) by banks. The carbon footprint improves the measuring of the transition risks of banks’ loan stock.

It is also a tool for monitoring how banks are implementing the national climate strategy as Finland transitions to a carbon-neutral society by 2035.