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2. Sustainability
Environmental, social and governance (ESG) risks continued to be important for companies in the financial sector in 2024. This trend will continue in 2025. The challenges of implementing effective measures to limit climate change will play a key role here, as will the increase in physical risks. BaFin will therefore focus in particular on how supervised entities deal with physical risks.
Climate risks: impact via two channels
On the one hand, climate change is affecting the financial sector through physical risks. These risks arise from the specific impact of climatic changes, such as extreme weather events. Physical risks give rise to enormous financial losses and personal injuries and can have an impact on banks’ loan portfolios or insurers’ loss amounts, for example. There is an upward trend in physical risks due to factors such as unabated global warming. This was most recently demonstrated by the devastating rainfall and flooding in Spain in the autumn of 2024.
On the other hand, climate change has an impact by way of transition risks. Sudden market price corrections can result from changes in social requirements, climate policy decisions and technological innovations. A specific example of this is the new version of the German Building Energy Act (Gebäudeenergiegesetz), which sets out higher requirements for the energy performance of buildings. These requirements could potentially have consequences for the valuation of properties and therefore also for their value as collateral in the real estate loan business.
Various priorities at banks and insurers
According to the 2024 stress test conducted by BaFin and the Deutsche Bundesbank at less significant institutions (LSIs) and a BaFin survey conducted in 2024 on how LSIs and insurance companies were dealing with the financial consequences of climate risks, banks are already considering physical and transition ESG risks as risk drivers in their risk inventory. However, banks have not yet seen any material impact on the main types of risk.
In the same BaFin survey, insurers stated that their predominant focus was on physical risks. This is consistent with empirical evidence: claims incurred due to natural disasters have been on the rise for several years. Insurers also indicated that they considered transition risks to be particularly relevant in the context of capital investment. In contrast to banks, insurers’ self-assessments generally consider physical risks to have a material impact on the main types of risk.
BaFin gives more weight to physical risks in supervision
BaFin has intensively analysed physical risks on the German financial market (see Figure 17). For example, it has analysed selected banks and insurers that are particularly at risk due to extreme weather, supply chain dependency or concentrated credit and market risks. According to BaFin’s findings, supervised entities have generally made progress in managing their sustainability risks. However, there is still room for improvement.
Challenges include the integration and processing of more granular data on physical climate risks. Banks and insurers have to draw on several sources of information in order to assess individual natural hazards, for example. Banks in particular are still in the early stages in this regard and are currently focusing on building up their data basis. Some of the ESG scores they use when granting loans are of relatively little informative value.
Figure 17: Physical risks mean risks for the financial sector
Source: BaFin diagram, as at December 2024
Banks and insurers are sometimes closely linked through risk transfers, particularly in the area of real estate loans and the protection of collateralised properties against natural disasters. It remains difficult to assess the probability of occurrence and potential losses as well as the future insurability of climate risks, since the risk situation is changing and historical data is only of limited value. To put this in context: banks often transfer risks to insurers and reinsurers. Insurers sometimes also pass on the risks to the capital market. In such cases, it is difficult to understand who ultimately bears the risks.
From BaFin’s perspective, supervised entities must deal extensively with the physical risks, since these can result in high costs in the short term, including for banks and insurers.
Greenwashing: information often not comprehensible
Greenwashing can damage trust in a functioning market. The risk of greenwashing is still high because there are as yet no clear definitions for sustainability characteristics. There is currently a heated debate about whether certain investments are suitable for sustainable products. This is the case, for example, with investments in military equipment. BaFin recommends clearly highlighting such investments in products that are advertised as sustainable. This would prevent misleading information from being passed on to consumers.
At present, the information published regarding the sustainability impact of products and services is not always easy enough to understand. This was reflected in a non-representative sample of disclosures made in accordance with the EU Sustainable Finance Disclosure Regulation (SFDR), which BaFin conducted in 2024: the supervised entities often formulated the pre-contractual information in general language and used unspecified terms to describe the sustainability characteristics.
They also frequently used ESG ratings to assess the suitability of the companies in which they invested. However, these ratings often assess a company’s financial climate risks – such as the extent to which climate change could harm the company itself. The question of whether such a company itself has a positive impact on sustainability aspects – i.e. whether it is itself making efforts to protect the climate, for example – sometimes plays no more than a subordinate role in the ratings.
Financial market participants should therefore give ESG ratings careful consideration before deciding to adopt them. They need to understand what these ratings represent and to what extent they are suitable for appropriately assessing the sustainability characteristics of a financial product.
BaFin's line of approach
- BaFin will continue to deal with physical risks in greater depth in 2025. It will present the results of its survey of LSIs and insurers for discussion at venues such as the third Sustainable Finance Conference .
- Furthermore, BaFin will analyse how selected supervised entities deal with physical and transition risks in their risk inventory. It will also analyse the role that adaptation to climate change and environmental risks play for companies. Environmental risks also include the loss of biodiversity.
- As part of its ongoing supervision and by means of spot checks, BaFin will review how companies in the financial sector are fulfilling the requirements of the EU Sustainable Finance Disclosure Regulation (SFDR).
- BaFin will be carrying out its new supervisory tasks under the EU Corporate Sustainability Reporting Directive (CSRD), which must still be transposed into national law.
- BaFin will also examine how it can make even greater use of its powers under prospectus law to prevent greenwashing – for example by prohibiting the advertising for a securities issue if it contains false information regarding sustainability.
- BaFin will be supporting national, European and international bodies in reducing the complexity of ESG-related regulation and in making it more consistent, for example with regard to transition plans. At the same time, BaFin will contribute ideas regarding practicable disclosure obligations for investors.
- BaFin will conduct analyses of climate risks in the real estate sector.
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