3.5 Bank of Finland analysed climate change impacts on financial system

Climate change and structural changes in the economy associated with the green transition require careful risk analysis. In 2022, the Bank of Finland also paid greater attention to biodiversity loss and its prevention.

Climate change and extreme weather events present risks for banks and other financial sector companies. The transition to greener technology can also bring risks if borrowers’ fossil energy-based investments are unused.

The financial markets have an important role to play in tackling climate change, because the transition to carbon neutrality requires large investments that need to be financed.

The potential risks to financial sector entities from climate change and climate policy are assessed by central banks and supervisory authorities.

Green transition requires the support of a functioning financial system

Imports of fossil fuels from Russia decreased substantially in 2022 following the outbreak of its war in Ukraine, and there is an obvious need to decrease dependency on these fuels both in Finland and in the other EU countries.

In summer 2022, Europe again experienced record heatwaves and drought, which also pushed climate risks higher up the agenda.

The Bank of Finland, under the direction of Deputy Governor Marja Nykänen, participated in the working group on financing the green transition set up by the Ministry of Finance, the Ministry of the Environment and the Ministry of Economic Affairs and Employment.

The working group drew up proposals for financing measures to accelerate the transition in an economically, ecologically and socially sustainable manner. Only a stable and well-functioning financial system will be able to provide the financing required by a long-term green transition. In December, the working group published its report on financing the green transition.

Energy supply is the most significant industry with transition risks

The Bank of Finland continued in 2022 to examine the impact of climate change on the financial system.

It analysed Finnish banks’ transition risks by examining the composition of their credit portfolios and claims on corporate sectors. In terms of transition risk, the most significant industry is energy supply. In this industry too, the risks in Finland are moderate and smaller than in many other countries. The results of the analysis were discussed in the Bank of Finland Bulletin article Climate change must be tackled – What does PACTA tell us about banks’ transition risks? (in Finnish).

In 2022, the Bank of Finland also started to pay greater attention to biodiversity loss and its prevention. This is more difficult to measure and analyse than climate change, and central banks have previously paid relatively little attention to it. An article on biodiversity loss (in Finnish) was published in the Bank of Finland Bulletin in November.

Central banks also continued to cooperate internationally on climate risks

The Bank of Finland is a member of the Network for Greening the Financial System (NGFS), which published new climate scenarios in September 2022.

The scenarios provide an illustration of climate change and its implications in the decades ahead. The new scenarios take into account new technologies and reflect the most recent country-level commitments to reach net-zero emissions.

The modelling of physical risks caused by heatwaves, drought, storms, excessive rainfall and other extreme weather events has been improved compared to the scenarios published in June 2021. The models can be used, for example, for assessing the impact of the materialisation of climate risks on the financial system.

The monitoring of climate risks in the financial sector requires new types of statistics and other numerical data. The Bank of Finland was actively engaged in 2022  in the work on global and comparable climate data, for example within the NGFS working group assessing data needs and data availability.

In July, the working group published a final report and a directory of climate change-related indicators. The Bank of Finland also actively promoted the development of climate indicators in the work of the Statistics Committee of the European System of Central Banks (ESCB).

The European Central Bank and the European Systemic Risk Board published a joint report in July on the options for a macroprudential policy response to the management of climate risks. The Bank of Finland also participated in the preparation of this report. Work on macroprudential policy and climate risks continues in the Eurosystem.