Banks have to evaluate risks every day, taking them into consideration in their investments and financing. One of the key regulatory frameworks used for risk controlling in the financial industry is the Minimum Requirements for Risk Management (MaRisk), a circular published by the BaFin (the German Federal Financial Supervisory Authority). The seventh amendment to the MaRisk adds an all new risk dimension with the topic of ESG, defining a framework of requirements for handling sustainability risks in the financial industry: Banks are obligated as actors to factor ESG into all of their risk-controlling measures.
The fact that ESG factors are mentioned frequently and explicitly in the BaFin’s instructions also clearly demonstrates their importance today in evaluating financial risks. Sustainability is an essential consideration when developing future-oriented business activities, and banks play a key role in this respect as they provide financing and support the transition. ESG risks, in turn, affect a wide range of areas, taking risks that were previously under consideration and amplifying them.
One example: extreme weather events – which are becoming more likely – can lead to more nature-caused damage in a given region. Reinsurance companies may no longer be able to cover this risk, while local banks are confronted with a high or even unacceptable level of risk when granting credit to regional companies. All of these issues need to be taken into consideration; institutions need to precisely identify and quantify the sustainability risks relevant to them, then include them in their risk assessments. The requirements are high, and ESG is to be seen as a scenario- and science-based risk “landscape”.
High transition risk for banks
This classification requires a high level of expertise and data, and covers a wide range of relevant information. Here is one example: The goal of climate neutrality is one of the most important issues. To establish appropriate incentives to reduce greenhouse gas emissions, the financial industry must be able to identify the sectors they invest in with the highest dependency on fossil fuels, then precisely calculate their corresponding greenhouse gas emissions. Stress tests in recent years have shown that they are, too often, still working with estimates, and that banks also frequently have a few large companies as the biggest greenhouse gas producers, by far, among their clientèle. This exposes these banks to a high level of transitional risk.
The 7th amendment to the MaRisk also focuses in particular on the long time period that must be considered for sustainability risk assessments, because actions taken today – such as emitting greenhouse gases – will have effects far into the future. The amendment requires that ESG risks be considered in early risk warning systems, and that customary short-term risk reviews be completed. In addition, it also requires that ESG risks and their development be considered over the long-term.
Sustainability must be a top priority
The amendment also explicitly stipulates that the highest level of management must be involved: Sustainability must become a top order of business! In light of their relevance for future viability not only for bank customers, but also for the financial industry itself, ESG factors are a key priority in strategic terms.
This quote from the consultation paper for the 7th MaRisk makes clear how seriously the BaFin takes ESG-related matters:
“The impacts of the risks resulting from climate change and the transition to a more sustainable economy (for instance due to social impacts) must be taken into consideration both in the standards and from an economic perspective in any forward-thinking assessment. Simply relying on historical data is not sufficient”.
Banks must approach all of these developments with dedication and seriousness. DSP is a reliable partner as they do so: As an IT company, we are well-versed on how to handle data, processes, and their digital implementation. Our ESG Practice Group supports this competence with extensive technical and regulatory expertise (cf. our blog post Sustainability in the financial industry – an overview of the main themes in 2023).