Should you be more afraid of droughts or typhoons?
Environmental risks are still widely underestimated by most financial institutions, leading to a misallocation of resources towards unsustainable assets.
The Network for Greening the Financial System (NGFS) published a Case Study for Environmental Risks Analysis Methodology to lay out and propose solutions to the main barrier to effective environmental risk analysis (ERA) for financial institutions.
Efforts to mainstream ERA affect many stakeholders, including regulators, central banks, service providers and financial and academic institutions, who need to:
- Enhance the awareness of the need for ERA: regulators can conduct ERA and clarify their expectations for financial institutions to raise awareness and pave the way for future policies.
- Develop analytical capacity and databases: any of these stakeholders can organise internal or open training and research activities and make some of the results public for the ecosystem to grow.
- Support demonstration projects: NGO, international organisations and regulators can invest in ERA projects and case studies to understand environmental risks better in some key sectors and contexts.
- Encourage disclosures of environmental risk exposures and ERA results: the same actors can work towards a consistent disclosure framework supporting ERA for both financial institutions and firms in the real economy.
- Develop key risk indicators and statistics: international organisations, including the NGFS, can conduct research to set up ERA frameworks and metrics for financial institutions.
- Support development and adoption of unsustainable finance taxonomies: policymakers can develop a taxonomy of activities that are the most exposed to environment- and climate-related risks.
Properly measuring, pricing and managing environmental externalities still requires addressing many institutional, technical and policy problems before financial institutions and the real economy are overwhelmed with unforeseen risks.