On December 8, 2020, the Monetary Authority of Singapore (MAS) published the Guidelines on Environmental Risk Management for Banks. These guidelines are aimed at improving the management of environmental risks by all banks, merchant banks, and finance companies, in line with the expectations of the MAS.
The primary objective of the guidelines is to enhance the banking sector’s resilience to and management of environmental risk through setting out sound risk management practices.
The guidelines are applicable to banks extending credit to corporate customers, underwriting capital market transactions, and other activities that expose banks to material environmental risk.
Banks face several risks such as
- Environmental risks: These include physical risks (from weather events and widespread, long-term environmental changes) and transition risks (related to adjusting to an environmentally sustainable economy with the requisite changes in public policy, technology, and consumer and investor preferences).
- Financial risks: The financial impact on banks’ portfolios and activities can arise through physical and transition risk channels, including:
- Credit risk: Rising frequency and severity of extreme weather events can impair the value of assets held by banks’ customers, or impact supply chains affecting customers’ operations and profitability, and potentially, their viability.
- Market risk: Banks may be exposed to a decline in valuation and increased volatility in their investments (particularly in carbon-intensive sectors and companies that have contributed to significant environmental degradation) as a result of shifts in investor preferences.
- Liquidity risk: Natural disasters can cause widespread damage on physical property and incur significant costs (e.g. construction and repair), leading to a surge in funds withdrawal and demand for emergency loans, and exacerbating liquidity stresses in banks.
- Operational risk: Severe extreme weather events can disrupt business continuity by negatively impacting the bank’s infrastructure, systems, processes and staff.
- Reputational risk: These come from banks financing customers that carry on business activities, which have a negative impact on the environment. Negative perception of such financing activities can adversely affect banks’ abilities to maintain or establish business relationships.
Source: 2020 Guidelines on Environmental Risk Management (Banks) – MAS
Environmental risks stem from the possible impact of environmental changes on economic activity and the well-being of people. These changes could include land use changes, pollution, and loss of biodiversity. The guidelines address environmental risks across three pillars.
- Governance and strategy: The guidelines clarify that the board of directors (Board) and senior management are required to identify environmental risks and opportunities over the short and long term, and to evaluate the actual and potential impact of these risks and opportunities on the bank’s strategies and business plans. They must maintain effective oversight of the bank’s environmental risk management and disclosure. They should also oversee the integration of environmental risks into the bank’s enterprise risk management framework.
As per the guidelines, the Board, or a committee delegated by it, is responsible for:
- Approving an environmental risk management framework and policies to assess and manage the bank’s environmental risk exposures on an ongoing basis
- Ensuring that environmental risk, where material, is addressed in the bank’s risk appetite framework
- Setting clear roles and responsibilities of the Board and senior management
- Ensuring that directors have an adequate understanding of environmental risks
- As per the guidelines, the senior management is responsible for
- Ensuring the development and implementation of an environmental risk management framework and policies, as well as tools and metrics to monitor exposures to environmental risk
- Regularly reviewing the effectiveness of the frameworks, policies, tools, and metrics, as well as making appropriate revisions
- Updating the Board on material environmental risk issues in a timely manner
- Allocating adequate resources with appropriate expertise
Policies and Procedures
- The bank should develop a risk management framework to manage environmental risk in a systematic and consistent manner, including:
- Clear articulation of the roles and responsibilities of business lines and functions in managing environmental risk
- Identification and assessment of environmental risk on a customer and portfolio basis
- Implementation of effective risk management practices and internal controls to manage environmental risk
- Effective monitoring of environmental risk and timely update to the bank’s Board and senior management.
- The bank should have in place a clear allocation of responsibilities for management of environmental risk in accordance with the three lines (Business line, risk management function and internal audit function) of defense model.
Risk Identification and Assessment
- The bank should identify material environmental risk at both customer and portfolio levels.
- The bank should apply risk criteria to identify sectors with higher environmental risk.
- The bank should assess each customer’s environmental risk as part of its assessment process for credit facilities or capital markets transactions.
- Transactions with higher environmental risk should be subject to the bank’s enhanced due diligence.
- The bank should take a consistent approach to environmental risk and issues across different business lines.
Risk Management and Monitoring
- The bank should actively manage and monitor its environmental risk exposures at both customer and portfolio levels.
- The bank should engage each customer that poses higher environmental risk and encourage the customer to improve its environmental risk profile and transition towards sustainable business practices over time based on its risk assessment.
- The bank should encourage customers to provide relevant corporate environment-related disclosures (to the extent appropriate and applicable), to foster greater awareness of environmental risk and engender responsible behavior.
- The bank should develop quantitative and qualitative tools and metrics to monitor and assess its exposures to environmental risk.
- The bank should provide all relevant information on its material environmental risk exposures to its Board and senior management to monitor progress against the bank’s risk appetite and business strategies, and to support decision making on environmental risk management.
Scenario Analysis and Stress Testing
- The bank should develop capabilities in scenario analysis and stress testing to assess the impact of material environmental risk on its risk profile and business strategies and explore its resilience to financial losses under a range of outcomes.
- The bank should include, where relevant, short-term and long-term environmental scenarios (using conservative and regularly reviewed assumptions) into its scenario analysis and stress testing for strategic planning and risk management purposes.
- The bank should use the results of its scenario analysis and stress testing when reviewing its environmental risk management policies and practices.
- The bank should equip its staff, including through capacity building and training, with adequate expertise to assess, manage and monitor environmental risk in a rigorous, timely and efficient manner.
- The bank should disclose its approach to managing environmental risk in a manner that is clear and meaningful to its stakeholders at least on an annual basis.
- The bank’s disclosure should be in accordance with well-regarded international reporting frameworks17, such as recommendations by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (“TCFD”).
- The bank should review its disclosure regularly to improve its comprehensiveness, clarity, and relevance, taking into account generally accepted measurement practices and methodologies.