Positive progress has been made in green finance globally despite the Covid-19 pandemic. One notable example is the growing consensus among central banks and regulators that enhanced environmental risk analysis is essential to greening global investments and protecting the financial system.
Environmental risk factors, such as rising sea levels, floods and other natural disasters, as well as transition shocks, threaten the financial industry and financial stability. As governments take action to reduce emissions and as progress is made in green technologies, exposure to polluting assets is higher risk. Institutional investors could see their assets devalued.
However, environmental factors have not been sufficiently factored into decision-making due to a number of barriers. These include a lack of data and methodology to conduct environmental risk analysis, and inadequate capacities to apply ERA in emerging markets.
Against this backdrop, the Central Banks and Supervisors Network for Greening the Financial System published its overview of environmental risk analysis by financial institutions on 10 September.
The ERA overview, and the accompanying NGFS occasional paper, ‘Case studies of environmental risk analysis methodologies’, provide reference tools and methods for financial institutions to measure their exposures to climate risks and quantify the financial risks arising from these exposures.
The overview gives a non-technical review of ERA tools and methodologies used by banks, asset managers and insurance companies.
It discusses the barriers to promoting ERA and options to address these. This covers increasing awareness among financial institutions, carrying out capacity-building activities on ERA tools and methodologies, supporting pilot projects, and promoting disclosures of ERA results.
The case studies introduce the ERA methodologies, models and applications developed by more than 30 leading institutions around the world. The 600-page report is the most comprehensive document on ERA to date.
Basic research frameworks and commonly used ERA methodologies should be public goods. A lot of effort may be duplicated and resources wasted if each financial institution has to invest individually in developing these methodologies. The overview and case studies provide such a public good for the members of the financial community seeking to enhance their capacities and further develop ERA methodologies.
All parties in the financial sector should work together to promote the wider adoption of ERA. Enhancing environmental governance in the financial sector would help prevent the threat to financial stability from environmental risks.
Financial resources would be more effectively steered towards green and low-carbon sectors, supporting a green recovery and the sustainable development of the global economy.
Ma Jun is Chairman of the Green Finance Committee at the China Society for Finance and Banking. This article originally appeared in the Sustainable Policy Institute Journal.