Increasing climate-related risks demand more action from the financial sector

Climate change and the energy transition lead to financial risks                                                       

The report addresses the consequences of climate change such as changes in the frequency of extreme weather and rising sea levels. Climate-related damage resulting from storms, hail and rain is usually insured in the Netherlands and hence has a direct impact on insurers. Large-scale flooding is often uninsured, but it can still have an impact on the assets of financial institutions through various indirect channels. The report also explores the consequences of the Paris climate agreement to limit CO2 emissions. This will create risks for the financial sector as a result of transition policy and technological developments. The market for green finance is also emerging, with its own opportunities and threats. 

Financial risks are already materialising in a number of areas. For example, Dutch insurers will have to deal with an increasing claims burden as a result of climate-related damage. This in turn may lead to shock-induced price rises in premiums. Furthermore, climate change is making it more difficult to estimate the likelihood of extreme weather. Non-life insurers often use disaster models provided by external parties to estimate the claims burden resulting from extreme weather. While these models are highly advanced, they often do not address climate change trends that are specific to the Dutch situation. This may lead to an underestimation of actuarial risks. 

The energy transition also leads to increasingly specific climate policies in various sectors of the economy. For example, France and the UK plan to end sales of diesel and petrol vehicles by 2040. In the Netherlands, all office buildings will be required by law to have at least a C level energy label as of 2023. This may affect the lettability and value of office buildings that do not meet this requirement. A sample check of commercial real estate portfolios in the Netherlands, including office buildings, revealed that around 46% of bank loans are secured with real estate collateral that has a poor energy label (levels D-G). Most financial institutions have not yet incorporated all relevant energy label data in their risk management systems. 

The financial sector acknowledges climate-related risks, but more action is needed.

In general, the Dutch financial sector is increasingly aware of climate-related risks and is taking steps in the right direction. For example, large banks have announced their intention to tighten the refinancing requirements for non-sustainable office buildings. Many large financial institutions are investigating their exposures to carbon-intensive sectors. Insurers too are increasingly aware of the consequences of climate change, as is clear from a recent report of the Dutch Association of Insurers. We also see that several insurers are addressing the uncertainties in their risk modelling by tightening reinsurance programmes. 

Additional steps still have to be taken, however. For example, institutions should apply more forward-looking methods in their risk management, such as scenario analyses. They must also make efforts to systematically identify climate-related risks and take relevant mitigating measures where necessary. This requires specific action. For example, financial institutions must take steps to incorporate relevant data on climate-related risks in their risk management systems to a greater extent. This includes making more efficient use of internal data as well as applying new risk indicators. In addition, insurers should take climate change adequately into account in their risk management and risk modelling. 

DNB's next steps to control climate-related risks

As the supervisory authority, we will take the necessary steps to contribute to financial institutions' adequate identification and control of climate-related risks. For example, we intend to embed climate-related risks more firmly in our supervisory approach and address them in our interviews with supervised institutions. We are also working on implementing and further developing climate stress tests. For example, we are currently conducting a climate-related stress test at non-life insurers and we are working on a stress test for transition risks.