The Riksbanks Climate Report 2021

How does the Riksbank work with climate-related risks?

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How does the Riksbank work with climate-related risks?

Financial stability

Published: 4 May 2022

The financial sector is important for stimulating sustainable investment

The financial sector plays a vital role in the climate transition. This is because it is through this sector that capital and savings are allocated to the sustainable investments needed to achieve the climate target of net zero emissions by 2045. In order to use capital to support the changeover in an efficient way, it is crucial that climate-related risks be taken into account in interest rates and asset prices. If the prices do not reflect these risks, the likelihood of large and rapid price adjustments will increase in the future, once the risks materialise. This applies both to physical risks such as forest fires, which could, for example, affect the prices of mortgages, properties or forests, and to risks resulting from the transition, which could, for example, affect possibilities for obtaining loans by companies in CO₂-intensive industries.

Participants in the financial system, such as banks, insurance companies, pension companies, asset management companies and financial market infrastructures, may also be exposed to such climate-related risks in various ways. In order to safeguard the stability of the financial system, it is important that banks and other financial agents deal with the climate-related risks to which they are exposed.

The need for better sustainability reporting is increasing

In order to measure, analyse and price climate-related risks in the financial system, there must be usable and comparable financial data. The availability of reliable financial data is a prerequisite if interest rates and asset prices are to reflect climate-related risks, and forms the basis of all analysis made by the Riksbank under the framework of the financial stability analysis. Without data, analysis becomes more complicated and it becomes more difficult to understand the risks present in the system. The Riksbank therefore supports the international work that is now under way to develop an international global standard for climate-related reporting. More information about this is presented in the third chapter of the report, which describes the basic work of the TCFD. The Riksbank has also initiated a number of projects at home in order to understand climate-related risks in the Swedish financial sector better and to follow up their management.[17] In line with the Riksbank's remit, the focus is primarily on the banking sector and its main borrowers (because they are a central part of the financial system), but also on other participants and markets from a systemic risk perspective.

Climate-related risks in the banks’ assets

The banks play an important part in the Riksbank’s stability analysis because of their central role in the financial system. Among other things, the loans the banks give to companies and households expose them to climate-related risks. The size of these exposures depends on how vulnerable different borrowers are to different climate risks. In addition, the banks’ other operations, such as fund operations, also expose them to climate-related risks.

The Riksbank has analysed the extent to which the Swedish banking system is exposed to various business sectors with high CO₂ emissions. This analysis uses 2020 data from the credit database KRITA and Statistics Sweden's data on greenhouse gases.[18] See C. Cella (2021), “Banking and climate-related risks, implications for financial stability in Sweden”, Staff memo, May, Sveriges Riksbank. The analysis indicates that approximately 12 per cent of the banks’ corporate lending went to companies in sectors with high or medium CO₂ emissions.[19] Loans to the property sector are not included in the study. The analysis indicates that a significant proportion of these loans (about a quarter) went to companies with weak financial positions. This study indicates how important it is to take into account the impact that climate-related risks, and transition risks in particular, along with other financial vulnerabilities, may have on the Swedish banking sector.

At present, the Riksbank is also conducting a preliminary study of available relevant climate-related data in combination with various tools and methods. Its aim is to see how much it is possible, for instance by using scenario analysis, to further develop the analysis and learn more about how financial stability may be affected by the climate transition. One way of gaining an idea of the risks the transition entails for the banks is to explore how their climate-related exposures stand up under different scenarios. Together with Finansinspektionen, the Riksbank has therefore launched an analysis of the loan portfolios of the three major Swedish banks. This analysis uses a tool called Paris Agreement Capital Transition Assessment (PACTA).[20] The Paris Agreement Capital Transition Assessment (PACTA) has been developed by a global think tank, 2 DEGREES Initiative, supported by the European Commission and the UN body UN Principles for Responsible Investment (UNPRI), among others. PACTA is used to assess how well companies are complying with the transition that needs to take place in each sector to meet various transition targets. It does this by combining data on the banks’ loan exposures with data from a variety of sources. The Riksbank then applies the transition targets to various climate scenarios developed by the International Energy Agency (IEA). We expect the results of the analysis to provide a snapshot of a limited but relevant portion of the banks' exposures to climate-affected sectors and the compatibility of these exposures with the transition targets.

Rising sea levels may affect financial stability

A physical risk that is already present in some areas of Sweden is the risk of flooding in coastal areas. For example, in some areas it is difficult or almost impossible to obtain planning permission and insurance for buildings too close to the sea. The Riksbank has therefore analysed how much flooding may affect coastal housing in Sweden when sea levels rise due to climate change, as well as the impact this may have on financial stability.[21] M. Danielsson (2020), “Rising sea levels due to global warming will entail increased risks to housing”, Economic Commentaries, No. 10, Sveriges Riksbank. If extensive flooding affects a house and causes it to fall in value, the borrower’s loan-to-value ratio will rise due to the lender’s collateral losing value. Higher loan-to-value ratios for households and lower collateral quality for credit institutions may have a negative effect on financial stability. The Riksbank’s analysis shows that the risks associated with floods in Sweden will increase in the future. How much the risks will increase depends on the severity of climate change. The extent to which this will affect financial stability also partly depends on how society adjusts to the new level of risk.