Climate-related transition risks must be given priority

2022-04-08 | Sustainability News Bank

The data and methods available for measuring climate-related transition risks are under development. There is a lot of work going on in this area, in the banks and in organisations at national and international level, but it is important that the banks calculate and manage these risks already today. It is no good waiting for better data and fully standardised and harmonised methods to become available. Finansinspektionen (the Swedish Financial Supervisory Authority) and the Riksbank have jointly applied the Paris Agreement Capital Transit Assessment Tool (PACTA) to measure climate-related transition risks in the banks' credit portfolios. The results show that there are transition risks that banks have to take into account.

Climate change brings both physical and transition risks. For example, buildings and facilities can be destroyed by natural disasters, and climate targets, technological advances or political decisions can put pressure on companies to convert their operations. Climate-related risks can lead to financial risks, and it is therefore important that the banks, as lenders, manage and understand how these risks affect the risks of loan losses and adjust their lending accordingly. It is also the responsibility of central banks and financial supervisory authorities to ensure that the financial system is resistant to this type of risk.

The results of our application of PACTA show that there are companies in the banks' loan portfolios that are exposed to transition risks. Many companies with a need for transition have difficulty meeting the climate targets set five years ahead. More than half of the bank lending that goes to activities that are directly harmful to the environment – a large part of which is made up of companies that extract fossil fuels – does not meet the targets. As the results are only valid for companies covered by the PACTA method and for which data is available, conclusions cannot be drawn at portfolio level. Nevertheless, we note that there are climate-related transition risks that the banks must take into account. To obtain a more comprehensive picture, and also to cover physical climate risks, the analysis needs to be supplemented with other methods and tools.

Despite the fact that a lot of work remains to be done before analyses of this kind are fully reliable, it is important that the banks begin working on assessing, quantifying and managing climate risks already today. Climate risks are a reality and it is not possible to wait for more comprehensive data and methods to become available.

Paris Agreement Capital Transition Assessment (PACTA) for banks is a method developed to analyse whether companies meet climate targets that are specified in different climate scenarios. The results can be used to support the analysis of transition risks in the banks' loan portfolios.

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