DNB publishes final Good Practice on climate-related risks for banks
In addition to the current COVID-19 crisis, the Dutch Central Bank (DNB) is concerned about another nature-related problem that potentially has a large impact on the financial system: climate change. Climate change poses new challenges to the risk management of banks. DNB expects that banks understand the potential impact of climate-related risks on their balance sheets and the topic has the full attention of the prudential supervisor. As part of its work in this field, on 1 April 2020 DNB published its final Good Practice: Integration of climate-related risk considerations into banks’ risk management and a related Q&A.
With these good practices DNB provides guidance on how banks can organize their processes and procedures to manage the climate-related risks related to their activities. In a nutshell, DNB expresses its expectations in relation to the following three topics and illustrates these with examples of good practices:
- Governance: examples demonstrating how a clear organizational structure with well-defined and transparent lines of responsibility for the management of financial risks stemming from climate change allow banks to appropriately address climate-related considerations in their risk management frameworks, while also contributing to organization-wide awareness of the financial risks to which the bank is exposed.
- Risk management process: examples of measures that banks can take to make climate-related risks measurable and actionable and to improve the risk identification, risk assessment, risk mitigation and risk monitoring in relation to climate-related risks.
- Disclosure: examples of how the collection and disclosure of climate-related information creates a degree of transparency essential for effective risk management and transparent shareholder involvement and which may ultimately contribute to a more efficient allocation of capital.
On 27 November 2019, DNB published this Good Practice and the related Q&A for consultation (please find our news report on this consultation here). The most important question for banks was whether these good practices included in the document are reasonable, effective and desirable and whether they actually offer tools for the further integration of climate-related risks into (i) the governance, (ii) the risk management and (iii) the disclosure of/by banks. DNB summarized the responses it received in a feedback statement. Most responses were centered around the challenges that banks face when integrating climate-related risk considerations into their risk management. Some of the important challenges that were mentioned, are:
- The limited availability of climate-related data and the probability of climate-related risks not being reflected in historical financial data.
- The uncertainty and non-linearity of climate-related risks, in particular in relation to the longer term character of climate-related risks, which presents challenges for banks’ existing risk management frameworks that generally have a shorter time horizon.
- The interaction of climate-related risks with other ESG risks that banks wish to factor in as well.
- The level playing field within the SSM when it comes to supervisory expectations related to climate risks.
DNB has acknowledged the challenges as outlined by the respondents. The Good Practice now mentions these challenges more specifically and DNB encourages institutions to take a holistic approach to environmental, social and governance risks when integrating them into their risk management framework. Furthermore, DNB states that its Good Practice is in line with regulatory and supervisory initiatives that are being developed at the European and international level. DNB announced that the ECB will also consult the market later this year on – among other things – its supervisory expectations on climate related risks. The European Banking Authority (EBA) will investigate how ESG risks can be incorporated in the annual supervisory review and evaluation process (SREP).
If you wish to read more on this topic, please also visit the blog that Bart Bierman wrote on climate risk requirements for banks.