Climate change is pushing banks to assess risks differently
It is necessary to expand the toolbox of methods in risk management to include ESG risks, which have not yet been addressed in a structured way in the credit process. Of course, dealing with risks has always been part of the business model of financial service providers, and risk management is one of the core skills of the industry. Normally, the risks considered in this context - such as liquidity, credit, market, or operational risks - focus on the impact on the institution itself. This is not the case with ESG (environment, social, government) risks: these act as so-called risk drivers on the other risk types, especially credit risk.
For this reason, it is imperative that banks consider ESG risks in all their facets and take a holistic approach. Regulatory pressure is also high: BaFin supervision, the ECB, and the European Banking Authority (EBA) expect financial institutions to create transparency on ESG risks. It is a matter of identifying the relevant risks to create the ability to manage them. The ecological aspect has a decisive influence on the business activities of banks. Accordingly, financial institutions need to respond by including physical ESG risks in their credit assessment in the future - just as insurance companies have been doing for a long time.
Dealing with ESG risks requires financial institutions to expand their toolkit of risk management methods. Understanding new impact mechanisms requires thinking in new categories. This means that risks must also be considered qualitatively. Institutions are forced to think much more long-term and to consider new influencing parameters that have not been in focus so far.
