‘The data challenge makes climate risk a very interesting but very complex scope of work’

Sandra Schoonhoven (ING)

‘The data challenge makes climate risk a very interesting but very complex scope of work’

Climate change poses a serious and growing threat to the entire world. In the necessary transition to a more sustainable economy, banks can play an important role. This is why sustainability – and climate in particular – is an important theme for ING.

As an internationally operating bank, it has a powerful tool: a financing portfolio of many hundreds of billions of euros. Sandra Schoonhoven heads ING’s Climate Risk Expertise Center. At the Zanders Risk Management Seminar 2022, she presented her approach around risk identification. We spoke to her about ING’s climate strategy and data as a big challenge.

A core element of ING’s strategy is “to put sustainability at the heart of what we do and help our customers transition to a low-carbon future.” For its own emissions (offices, data centers and travel movements), the bank aims for net-zero greenhouse gas emissions. But the biggest impact is in ING’s loan portfolio (corporate loans and mortgages). That’s why ING – like many other banks – joined the Net-Zero Banking Alliance in 2021, which aims to reduce global greenhouse gas emissions to limit global warming to no more than 1.5 degrees Celsius. In addition to measuring the impact of specific sectors annually and setting interim targets for each sector, the bank is also taking concrete actions. Examples include stopping financing for new oil and gas fields, increasing financing to renewable energy by 50% between now and 2025, and a sustainability discount on mortgages for homes with energy label A or higher.

Even in a world where we manage to limit global warming, climate risks will increase

In addition to reducing emissions in its own operations as well as in its loan portfolio, the bank is measuring and managing climate risks. Because even in a world where we manage to limit global warming, climate risks will increase. This involves physical risks, such as floods and forest fires, and transition risks – for example, from changing policies or technological developments that could affect the loan portfolio.

Terra approach

“Climate has long been an important part of ESG policy for us. Our biggest impact on climate is our financing,” says Sandra Schoonhoven, Lead Climate Risk Initiative at ING. “In recent years, we have therefore put a lot of energy into our Terra approach, a methodology to make the climate aspects of the financing portfolio transparent. We’ve been working on that for a long time – we recently published our fourth report on this subject. We examine per sector to what extent we are in line with the most ambitious targets in the Paris Agreement on climate change and link our targets to them. For example, for the nine most carbon-intensive sectors, we measure whether our lending is contributing to achieving net-zero.”

How exactly do you address climate risk as a bank?

“Climate risk, and the expertise and data it requires, has only recently really started to develop as an area of focus, influenced in part by the European Central Bank (ECB) guidelines, which describe how the ECB expects the financial sector to deal with climate risks. An important first step is to identify and assess climate risks, in order to map their potential impact. We recently completed this identification and assessment for sectors we finance and for our mortgage portfolio and reported in our Climate Report. In addition, we have had a very thorough Environmental and Social Risk Framework for years, which indicates which sectors and business activities we identify or exclude as ‘high risk’.”

What risk components are involved?

“All of them. We engage with credit risk, operational risk, market risk, the stress testing team – It’s very broad, because climate risk impacts all risks of business operations, so not just credit risk. Therefore, at the beginning of this year, we have set up an Integrated Risk team within our Risk department, which applies a holistic approach to our risk management. Within that team, there is an ESG Risk team that particularly focuses on the regulations surrounding risk and their interpretation. Many financial institutions approach climate change purely from a risk perspective, and I think that makes sense.

“Climate change is approached purely from a risk perspective at many financial institutions, and I think that makes sense. At the same time, good knowledge about climate risk and climate adaptation also provides opportunities”

At the same time, good knowledge about climate risk and, for example, climate adaptation (timely adaptation to climate change, ed.) offers opportunities too. And reporting on climate and climate risk is also increasing, so in addition to Risk, more and more business units are working on and involved in the subject. That’s where my team’s role comes in: connecting all disciplines and providing expertise on climate risk.”

Is credit risk the most important climate-related risk form?

“Indeed, for a financial institution, this is often the case because the impact is primarily with our customers. Our customers’ assets – which ING finances – could flood or decrease in value because of the energy transition. I think the awareness about the potential impact of climate as a company, but also as individuals, can be much better. We are all still not sufficiently aware that assets – whether a business, home or car – can be affected by climate risk. Both through physical risks, such as flooding or damage from more severe storms, and transition risks, so through legislation, market preferences or depreciation of non-energy-efficient activities or possessions. I also see that awareness creation and agenda-setting as a task of my team – starting in our own organization through education and information, and then through our employees to our customers.”

To apply it in risk models, you will also need to quantify climate risk. How do you deal with that?

“That is indeed a challenge. To quantify, you need data. And to know what it means, that data has to be translated. For example, you can have data on physical risk, such as the number of homes where there is an increased risk of flooding from rivers. Or on transit risk, like the number of homes with poor energy labels. And obtaining that data is sometimes difficult. For example, energy labels are not issued as publicly as they are in the Netherlands. But such data by itself does not lead to changes in risk models. You have to be able to interpret that data and understand how climate risk leads to financial risk. For example, what does an increased risk of forest fire do to home values in that particular region, or what happens to productivity if a company faces flooding? Making such connections is difficult – especially to put a monetary value on it, such as ‘houses with these criteria or in that area drop by x percent’.”

So data poses the biggest challenge?

“Yes, because apart from the data needed and being able to quantify it, there is also historical data missing to model with. That data is simply not there. Temperatures on earth have increased before, but then all our houses, infrastructure and industry weren’t there yet. And it did get warmer or colder before, but not as fast as now. In other words, this situation is unique.

Collecting all the data about the current situation is also a challenge. Especially for many of our clients, because they too have to start reporting on the sustainability of their operations. Many already must comply with the NFRD (Non-Financial Reporting Directive) and soon the CSRD (Corporate Sustainability Reporting Directive). So we also depend on the quality of the data that our clients have to offer, in order to be able to report back on our portfolios.

“Data is also a challenge for many of our clients, because they too need to start reporting on the sustainability of their operations”

Finally, there is the challenge with different reporting standards. Not all of our clients are covered by the NFRD or CSRD, and therefore do not have to comply with that legislation. The USA, for example, has yet another reporting standard. But all the current movement and attention is good. And eventually I am convinced that we will get non-financial reporting to the same level as financial reporting.”

If you have the data to identify risks, how do you categorize clients based on climate risk?

“We looked at 26 physical and 7 transition risks for each (sub)sector and rated them with ‘low’, ‘medium’ and ‘high’ for that specific (sub)sector. Then we looked at our clients in those (sub)sectors and adjusted the score if necessary based on the profile of those clients. The outcome is reflected in a heatmap per (sub)sector and the scores from that heatmap are input for our climate credit risk policy.”

How do you approach this for mortgages?

“There it involves different data. We have energy labels and know things about transition risk based on government policy. We also know from 99% of our global mortgage portfolio which of the physical risk events can reveal for a specific mortgage. For 1% of all mortgages, we now see a ‘high’ or ‘very high’ risk of physical risk events. That may seem low, but even with a less ‘high’ score, events can take place.”

How do you provide data about the future?

“The data we use generally looks at 2030, 2050 and 2100, under different RCP scenarios (see boxed text). For mortgages, for example, we look at relevant scenarios based on current risks and those in, say, 2030. Corporate loans tend to have shorter maturities, so we can focus more on current data on climate risk there.”

So what is the next step to take?

“We need to integrate climate risk management into existing risk frameworks. We don’t want separate models for climate risk. In fact, climate risk is never the only risk. There are all kinds of drivers that are important to arrive at the right judgment. We have to look at it as an integrated whole. Even things that are already sustainable, such as solar panels, have a physical risk that you have to include. It is not an easy task and mostly complex, but extremely relevant for us as a bank and for society.”

RCP scenarios (where RCP stands for Representative Concentration Pathways) are used in the fifth report of the United nations’ (UN) Intergovernmental Panel on Climate Change (IPCC). These scenarios describe the development of greenhouse gas emissions leading to climate change. The lowest emissions scenario is likely to lead to a temperature change of less than two degrees Celsius compared to the pre-industrial era. Work is underway to further extend the RCP scenarios for even longer time frames – to 2300 – so that the effects of slow processes, such as the melting of large amounts of polar ice and glaciers, can also be better mapped.

Sandra Schoonhoven was one of the speakers at our Risk Management Seminar.