Financial institutions

Going Green with Regulatory Technology for Financial Institutions

As the popular adage goes, “change is the only constant” and climate change fits the bill perfectly, as every notable change in climate patterns poses an increased risk to financial stability. It is therefore not surprising that climate risk continues to be one of the main agendas of banking and financial institutions.

As regulators, banks and financial institutions continue to explore options to better manage financial risks emanating from climate risks. From a technology perspective, regulatory technology (commonly known as RegTech) emerges as a key technology enabler for climate risk management. RegTech refers to the use of new technologies to solve regulatory and compliance issues more effectively and efficiently.

But before discussing how and where RegTech can help, some key constructs need to be in place for financial institutions to enable meaningful adoption of RegTech, namely:

  • Establish a corporate climate risk strategy and framework that considers geographic climate change requirements, along with a robust operating model and measurable key performance indicators
  • Establish climate risk policies and procedures and communicate the climate change agenda to all levels of the organization
  • Increased participation in green finance by focusing on a portfolio of greener products such as green bonds and better priced loans to climate-friendly counterparties.
  • Establish a RegTech adoption framework for climate risk management, including assessment and identification criteria to identify climate risk areas that can be addressed using RegTech
  • Leverage existing RegTech solutions that can be extended to manage climate risk. For example, existing regulatory reporting solutions can be extended to handle regulatory reporting related to climate risks.
  • A robust reporting mechanism that provides relevant climate information as required by internal and external stakeholders

Currently, climate risk management is grappling with a multitude of challenges which mainly include:

  • Lack of a holistic view at the enterprise level of climate risk and its contact points on the different types of existing risks
  • Availability of data. Data is a key ingredient in climate risk management. Whereas for traditional risk historical data reflects areas where organizations are most exposed, in the case of climate change there are multiple uncertain risk events that impact it.
  • Data taxonomy. Currently, there are a limited number of data standards and taxonomies defined for collecting data for climate risk management.
  • Climate risk modeling capacity. Expanding new scenario variables related to climate risk for which no projections have been provided requires climate risk modeling capabilities.
  • Analysis of individual counterparties. This requires assessing a counterparty’s current vulnerability given the impact of scenario variables and a counterparty mitigation and adaptation plan, which is not part of credit risk assessment today. today.
  • Disclosure management. Banks and financial institutions are already reeling from huge regulatory disclosure requirements, and additional climate-related disclosures will add to the existing workload.

Although the existing challenges present a difficult path to effective climate risk management, there are areas where RegTech can ease the burden, such as:

  • Leverage RegTech solutions to measure and assess the impact of climate risk regulations and policies on existing business processes, data requirements, and disclosure management.
  • Leverage machine learning-based RegTech to create hypothetical datasets that can be used as inputs into stress-testing models and to better assess risk from extreme events.
  • Leverage statistical tools, to generate climate-specific scenarios, perform simulations and analysis, simulations for better stress testing to improve risk management and governance framework.
  • Leverage RegTech data solutions for climate risk monitoring and environmental data.
  • Leverage artificial intelligence to derive predictive insights from generated climate reports for active decision-making.
  • Expand existing RegTech regulatory reporting to standardize and integrate climate-related disclosures.

Since the adoption of the Paris Agreement, various regulatory bodies have made many efforts to improve the understanding and adoption of climate risk management in banks and financial institutions. These efforts by various bodies include the Network for Greening the Financial System, Prudential Regulatory Authority and the TCFD Framework (Task force on Climate Related Financial Disclosures), which have laid the foundation for effective climate risk management.

Going forward in the post-pandemic world, efforts will need to be two-fold: one from the banks themselves to create a robust climate risk framework suited to their business strategy; and a second from global regulators who will need to set climate risk guidelines for their specific geographies. Such efforts will eventually bring climate risk into the mainstream, along with other types of risk. In this green journey, RegTech Solutions is slowly but surely emerging as an essential partner that can bridge some of the existing gaps and provide the necessary wings for the widespread adoption of this concept.