INTRODUCTION
STUDY MOTIVATION
Globally, climate change is regarded as a central issue of the 21st century for all economies Earth's temperature has risen by over 2°C compared to pre-industrial times, and if current greenhouse gas emissions, especially carbon dioxide (CO2), continue to increase, the average temperature rise could exceed 2°C by 2030 and 4°C by 2100 (Bernal-Ramírez & Ocampo, 2020) At the 21st United Nations Conference on Climate Change in Paris, with representatives from 195 countries (including Vietnam), through the Paris Agreement, a new era of global development has been initiated, characterized by low-carbon emission development, environmentally friendly production and consumption models, reduced dependence on fossil fuels, and promotion of renewable energy development As of August 2023, there have been
26 COP meetings organized, within the framework of COP meetings, countries negotiate measures to minimize the impact of climate change and share responsibility in implementing these activities Previously, these solutions primarily applied to non- financial sectors However, in recent decades, this view has changed, and the financial sector, particularly banking, is increasingly affected by environmental issues (McKenzie & Wolfe, 2004) To mitigate these risks, banks worldwide are striving to enhance climate risk management The Bank of America has committed to achieving net-zero greenhouse gas emissions by 2050 and investing $1 trillion in sustainable finance by 2030 to combat climate change (Bank of America, 2021) Similarly, Citigroup has pledged to reduce net greenhouse gas emissions from its activities and supply chain by 2050 and will fund $1 trillion for sustainable development projects by 2030 (Citigroup, 2021)
Vietnam, a country facing environmental issues and heavily affected by climate change, has actively participated in international commitments to reduce greenhouse gas emissions and mitigate the impact of climate change while striving for sustainability Vietnam is among the countries most severely affected by climate change (World Bank, 2021) The Vietnamese government actively participated in the United Nations Framework Convention on Climate Change in 1992, the Kyoto Protocol in 1997, the Paris Agreement on Climate Change in 2015, and signed many international bilateral agreements to cope with climate change Despite allocating significant financial resources to climate change priorities, efforts remain insufficient, failing to meet the needs for human resources, technology, infrastructure, and finance Globally, the banking industry and financial institutions have implemented guidelines for managing and controlling environmental risks in the financial sector, such as the Basel Committee on Banking Supervision (BCBS), the Financial Stability Board (FSB), and the Network for Greening the Financial System (NGFS), establishing a financial supervision framework related to climate change to address the threat of climate change to financial stability, but the banking sector's response to this situation remains slow (Nie et al., 2023) In 2022, the BCBS issued guidelines for the effective management and supervision of climate-related financial risks Fulfilling commitments, Vietnam has been and is implementing solutions to reduce the impact of climate change on both the non-financial and financial sectors Faced with pressure regarding environmental responsibility and sustainable development in the financial sector in general and banking in particular, the Ministry of Finance and the State Bank of Vietnam (SBV) has issued Circular No 17/2022/TT-NHNN guiding on environmental risk management in credit activities for credit institutions and foreign bank branches on December 23, 2022
The significant shortage of tools to detect and warn of significant financial risks has made financial management subjective and underestimated the value of underlying risks in the financial system (Engle, 2018) Therefore, developing tools, ratings, and monitoring financial system risks for commercial banks, as well as the entire banking system, is crucial This is particularly important for countries with economies relying on bank credit capital, such as Vietnam, where the financial market structure based on bank credit capital is vulnerable to systemic risks compared to market-based financial market structures When crises occur, the impact on these countries becomes more severe, causing significant consequences for the economy (Bats & Houben, 2020)
With the desire to provide an overview of the implementation and management of climate change risks related to risk management activities of commercial banks in Vietnam, this analysis will focus on evaluating the current status of climate change risk management implementation at commercial banks based on recommendations from international organizations and practices applied in some countries worldwide From there, recommendations will be proposed to enhance effective policies and guidelines for monitoring financial risks related to climate change in Vietnam Therefore, the author has chosen the topic "Climate-related financial risk management at Joint stock commercial banks in Vietnam" for their thesis.
RESEARCH OBJECTIVES
This study aims to assess the current practices of commercial banks in implementing measures and procedures guided by the Bank of International Settlements (BIS) and international financial organizations to address financial risks arising from environmental factors such as climate change and other environmental impacts Subsequently, the author proposes recommendations and policies for joint- stock commercial banks in Vietnam regarding the management of financial risks related to climate change
Derived from the general objective, the study is conducted to achieve the following specific objectives:
(1) Firstly, assess the current situation and level of compliance of commercial banks in Vietnam with the principles and guidelines related to environmental financial risks issued by the BIS
(2) Secondly, review the risk management measures and banking policies implemented to address climate-related financial risks within the framework of financial risk management of banks
(3) Thirdly, propose improvements and optimizations to enhance the effectiveness of financial risk management related to climate change at commercial banks in Vietnam.
RESEARCH QUESTIONS
Having established the research objectives as presented above, the following research questions are formulated:
(1) What is the current status and extent of implementation by commercial banks in Vietnam of disclosing financial risk management related to climate change as per the recommendations of the BIS regarding financial risks associated with climate change?
(2) How have Vietnamese commercial banks implemented measures to control and manage climate-related financial risks within the banking sector?
(3) Which recommendations are suitable to propose for commercial banks in Vietnam to enhance the disclosure of financial risk management related to climate change?
RESEARCH SCOPE
The research focuses on assessing the implementation status of commercial banks regarding climate-related financial risks in Vietnam The scope of the study includes 27 joint-stock commercial banks in Vietnam during the period from 2020 to
RESEARCH DATA AND METHODS
1.5.1 Data sampling, data collecting, data processing
The research sample comprises 27 joint-stock commercial banks out of the total number of such banks in Vietnam during the period from 2020 to 2023, excluding banks involved in buying and selling, mergers, 100% state-owned commercial banks, banks with 100% foreign capital, and foreign bank branches in Vietnam due to insufficient data (Table 1.1)
The research timeframe spans from 2020 to 2023, during which guidelines and regulatory frameworks pertaining to the management of financial risks associated with the environment have become progressively clearer, considering the current time, which also accounts for the collection of the latest information disclosures and annual reports from commercial banks (the 2023 annual reports are expected to be published around March to April 2024) In May 2020, the NGFS organization officially released the "Guide for Supervisors Integrating Climate-related and Environmental Risks into Prudential Supervision," and in June 2022, the BSCS organization announced the "Principles for the Effective Management and Supervision of Climate-related Financial Risks" During the period from 2020 to
2023, a time when joint stock commercial banks in Vietnam commenced active engagement with climate change, reports related to the environment gained increased emphasis, and policies for managing the system of environmental and social risk management in banks gradually saw improvement
Table 1.1: List of 27 commercial banks researched
An Binh Commercial Joint Stock Bank ABB
Asia Commercial Joint Stock Bank ACB Vietnam Bank for Agriculture and Rural Development AGR
Bac A Commercial Joint Stock Bank BAB
Joint Stock Commercial Bank for Investment and Development of Vietnam BID
Viet Capital Commercial Joint Stock Bank BVB
Vietnam Joint Stock Commercial Bank for Industry and Trade CTG
Vietnam Export Import Bank EIB
Ho Chi Minh City Development Joint Stock Commercial Bank HDB
Kien Long Commercial Joint Stock Bank KLB
Lien Viet Post Joint Stock Commercial Bank LPB
Military Commercial Joint Stock Bank MBB
Vietnam Maritime Commercial Joint Stock Bank MSB
Nam A Commercial Joint Stock Bank NAB
Orient Commercial Joint Stock Bank OCB
Prosperity and Growth Commercial Joint Stock Bank PGB
Saigon Bank for Industry and Trade SGB
Saigon-Hanoi Commercial Joint Stock SHB
Southeast Asia Commercial Joint Stock Bank SSB
Saigon Thuong Tin Commercial Joint Stock Bank STB
Vietnam Technological and Commercial Joint Stock Bank TCB
Tien Phong Commercial Joint Stock Bank TPB
Vietnam Asia Commercial Joint Stock Bank VAB
Joint Stock Commercial Bank for Foreign Trade Of Vietnam VCB Vietnam International Commercial Joint Stock Bank VIB
Vietnam Prosperity Joint Stock Commercial Bank VPB
Source: Synthesized by the author
This study primarily aimed to evaluate the level of financial risk management practice, specifically climate-related financial risk management, in commercial banks in Vietnam Additionally, an effort was made to assess the progress in developing internal assessment frameworks and the level of compliance with environmental risk management among commercial banks in Vietnam As the concept of climate-related financial risk management is relatively novel in emerging scenarios, the study employed the following research methods:
The study utilizes content analysis methods referenced in Bowman (1984) and Stemler (2015) for the first two questions The authors extract textual data annually from annual reports, sustainable development reports, and financial reports published on the official websites of banks from 2020 to 2023 The study employed Vietnamese textual data, searching for keywords such as “phat trien ben vung”, “tai chinh lien quan den khi hau”, “rui ro tai chinh chinh lien quan den bien doi khi hau”, “tin dung xanh”, “tai chinh xanh, “ngan hang xanh"" Furthermore, the study focuses on searching within annual reports, sustainable development reports, and financial reports for relevant information and keywords in sections such as "Corporate Governance," "Risk Management," "Environmental and Social Impact Reports," and
"Sustainability Content," which may be substituted with similar keywords depending on the bank's report Additionally, for information published on the official websites of banks and searching tool on Google, the study applies similar keyword searches in both Vietnamese and English languages using the "exact phrase" option in the "all" category, covering the period from January 1, 2020, to December 31, 2023
Furthermore, to gather supplementary information, the study utilizes secondary data sourced from bank websites, mainstream media sources on Google, and Google Scholar to assess the operational status of commercial banks in Vietnam Subsequently, content analysis methods are employed to collect data from sources such as information posted in relevant newspapers and magazines The collected information and data will be compared and cross-referenced with BCBS advisory documents under BIS to evaluate the implementation level and statistical status at commercial banks in Vietnam Following this, the study will employ quantitative analysis methods to measure the implementation level and effectiveness of financial risk management measures at commercial banks in Vietnam
Based on the results obtained during the research process, the authors will provide recommendations to enhance banks' compliance with regulations regarding environmental financial risks Furthermore, the study suggests potential avenues for further research to address the limitations encountered in this investigation.
RESEARCH CONTENT
This research seeks to identify the regulations governing the management of financial risks related to the environment within commercial banks Subsequently, it aims to assess the compliance level of commercial banks in Vietnam regarding adhering to financial risks associated with the environment The study will employ both theoretical frameworks and empirical research conducted by scholars domestically and internationally concerning financial risks related to the environment Through a comprehensive analysis, the research will provide insights into these issues, specifically focusing on 27 Vietnamese joint-stock commercial banks during the period from 2020 to 2023
Drawing from the findings obtained during the research process, the authors will present recommendations to enhance banks' compliance with regulations pertaining to environmental financial risks Furthermore, the study proposes future research directions to address limitations encountered in this investigation.
RESEACH CONTRIBUTIONS
The research project on "Climate-related financial risk at Joint stock commercial banks in Vietnam" holds particular scientific significance in the current context, where climate change poses significant challenges to the global economy and financial systems The significance of this study includes:
Firstly, the research contributes to a deeper understanding of the impacts of climate change on the commercial banking sector and the global financial system By exploring the effects of climate change, the study sheds light on its implications for commercial banks, thereby enhancing our understanding of this critical issue Additionally, the study highlights key points from the BIS guidelines
In academic term, while researches on climate-related financial risk management in commercial banks globally has been well-established for some time, with over a million research results available on Google Scholar, such research remains relatively new in Vietnam Previous studies in Vietnam have mainly focused on theoretical aspects or have centered on policies from the SBV The specific examination of compliance with and management of climate-related financial risk in Vietnamese commercial banks is lacking, making this study a pioneering endeavor in the field
In practical terms, the research evaluates and presents practical insights into how Vietnamese commercial banks develop, establish, and implement measures to address financial risks stemming from climate-related factors It offers an objective view of the strategies and measures employed by banks to manage and mitigate the impact of these risks Furthermore, the study identifies and highlights existing gaps and deficiencies, providing valuable insights for Vietnamese commercial banks to improve their risk management practices Additionally, the research proposes practical measures for banks to enhance their effectiveness in addressing persistent challenges and recommends that the SBV review and supplement legal frameworks to provide guidance and oversight for commercial banks in Vietnam.
RESEARCH STRUCTURE
In addition to the appendices, table of contents, and references, the research is presented in the form of four chapters
The author will provide an overview of the dissertation topic, the urgency of the research, the research subjects, objectives, and scope A brief overview of the research methods to be used in the article will be outlined.
LITERATURE REVIEW
CLIMATE-RELATED FINANCIAL RISKS
Climate-related financial risks refer to the set of potential risks that may result from climate change and that could potentially impact the safety and soundness of individual financial institutions and have broader financial stability implications for the banking system (BCBS, 2022)
Climate-related risks are divided into two primary categories: Transition risks and Physical risks (TCFD, 2017)
Transition risk refers to the risks resulting from changes to policies, technology and people’s preferences that are brought about by climate change For example, policies on the pricing of emissions will affect the return from emissions-intensive assets, and people’s preferences for green energy can have separate yet similar effects
Physical risk emerging from climate change are divided into two categories: acute or chronic Acute physical risks are those that are triggered by a specific event, such as an increase in the severity of extreme weather phenomena like hurricanes, floods, or cyclones Chronic physical risks, on the other hand, are caused by long- term changes in climate patterns, such as continuous high temperatures that could lead to sea level rise or recurrent heat waves
2.1.2 Methods of measuring climate-related financial risks
Among the various risk measurement processes currently being applied by banks and supervisory agencies, prominent methods for monitoring climate-related financial risks include: (i) Climate risk scores or ratings; (ii) Scenario analysis; (iii) Stress testing; (iv) Sensitivity analysis (Basel Committee on Banking Supervision, 2021)
Climate risk scores or ratings: Climate risk scores assess the level of climate risk associated with assets, enterprise investment portfolios, or nations This method combines risk classification with a scoring criterion to assign quality scores to categorized risks The scoring criteria used in these methods may be based on qualitative or quantitative factors Climate risk scores can help banks and supervisory agencies evaluate the relative climate risk level of current and future credit intermediary activities The methods and criteria for ranking climate risks between banks and other entities include approaches developed with high-detail data, particularly by location, supply chain, and specific subject information However, this method may have biases in cases of smaller partner data and short data histories
Scenario analysis: Climate scenario analysis forecasts future risk outcomes and is typically conducted in four steps: (i) identifying physical and transitional risk scenarios; (ii) linking the impact of scenarios to financial risks; (iii) assessing counterparties and/or industries sensitivity levels to those risks; (iv) extrapolating the impact of these sensitivity levels to calculate aggregated exposure and potential losses Scenario analysis can be performed at various detailed levels to identify impacts on individual risks or investment portfolios By testing the impact of a range of plausible scenarios, scenario analysis can also aid in quantifying risks and clarifying uncertainties inherent in climate-related risks
Stress testing: Stress testing is a specific subset of scenario analysis, often used to assess the short-term recovery capacity of a financial organization against economic shocks, typically through capital adequacy targets Generally, when considering payment capability, there are two types of stress tests: System-wide stress testing, measuring the impact of financial shocks on the financial system, which can cause systemic risks; and micro-level stress testing, assessing the payment capability of a financial organization, individual, with investment portfolio risks Recently, stress testing has been expanded by some banks and supervisory agencies to include climate-related financial risks Climate stress testing evaluates the impact of severe but plausible climate scenarios on the recovery capabilities of organizations or financial systems
Sensitivity analysis: Sensitivity analysis is also a subset of scenario analysis used to assess the impact of a specific variable on economic outcomes In these analyses, a parameter is altered multiple times through scenario runs to observe the range of output results from the scenario In certain cases, some parameters may be altered to observe interactions between parameters Sensitivity analysis is often used in assessing transition risks to analyze the underlying effects of a specific policy related to climate, particularly in industries related to carbon theory.
THEORETICAL BACKGROUND
Based on the theory and factors influencing the disclosure of financial risk management information related to climate change by businesses mentioned above, disclosing information about environmental risks and the bank's policies on climate risk management can reflect the bank's level of legal compliance, thereby gaining societal support and contributing to the development of the business Therefore, if the legal framework is not strong enough, it may weaken the disclosure activities of the business (Roberts et al., 2005) Hence, this study focuses on evaluating the legal framework of the State Bank of Vietnam regarding the disclosure of climate risk management information by the banking system in Vietnam
The theory of legitimacy is a system-oriented theory, meaning that an organization both influences and is influenced by the society in which it operates (Deegan, 2002) According to the theory of legitimacy, companies always strive to ensure that they comply with the norms and standards of the society in which they exist These norms and standards are not fixed; rather, they evolve over time, requiring organizations to adapt (Brown & Deegan, 1998)
Legitimacy is believed to be associated with the concept of "social contract" or
"license to operate." The social contract is drafted between the organization and society and is shaped by prevailing standards Society can revoke this contract if the organization acts improperly (Brown & Deegan, 1998; Deegan, 2002) The continuity of a company depends on the ability to act in congruence with the society's expectations, it is expected that it will strive to have its activities accepted and perceived as legitimate (Dias Filho, 2012) For this reason, corporations tend to strive to be perceived as socially responsible organizations (Suchman, 1995) Whenever the expectations of the "relevant public" regarding the organization's activities clash with the actual activities of the organization, the legitimacy of that organization is endangered This phenomenon is referred to as "legitimacy gap" (Brown & Deegan, 1998) If the legitimacy gap arises due to the organization's misalignment, the organization's viability will be significantly reduced (Oliver, 1991)
By disclosing financial risk information related to climate change, businesses demonstrate their compliance with social standards to the public, making it an important corporate communication tool for companies to achieve their strategic objectives Therefore, the theory of legitimacy is a significant driver for companies to disclose more risk management information to align with legal regulations, thereby achieving sustainable growth through societal consensus (Eccles & Viviers, 2011) Legitimacy theory emphasizes maintaining legitimacy and societal acceptance By disclosing information on climate-related financial risk management, companies enhance their chances of gaining recognition and acceptance from the community, fostering a stable and sustainable business environment
Institutional theory, which examines the factors influencing the overall productivity of businesses (Kostova & Marano, 2019), is a topic frequently explored in academic literature, given the crucial role of information disclosure in shaping a firm's reputation for integrity (Campbell, 2007) Firms operating in similar institutional environments tend to adopt comparable courses of action, reflecting how the theory can shed light on the impact of social and environmental initiatives on business performance (Bilyay-Erdogan, 2022) theory highlights the influence of organizational environments and societal factors on organizational behavior Companies often act in line with established patterns within their organizational and societal environments Disclosure of information on climate-related financial risk management reflects the organization's adaptability to meet the requirements and expectations of its organizational and societal environment
Signaling theory, rooted in the concept of asymmetric information, posits that in situations where there's a disparity in information, the party possessing the information must send signals to the party lacking it to achieve specific objectives (Connelly et al., 2011) Consequently, increasing channels of communication enhances information availability between companies and stakeholders, thereby mitigating information asymmetry (Peng & Isa, 2020) The disclosure of climate- related financial risks serves as a voluntary tool for providing information, aiding investors in forecasting economic returns Signaling theory focuses on transmitting messages and creating signals for stakeholders Disclosure of information on climate- related financial risk management can be used as a signal to demonstrate a company's commitment to risk management and environmental protection, thereby building trust and enhancing the company's reputation Hence, companies utilize it to signal sustainable outcomes, thereby bolstering corporate reputation
In recent years, society's concern for environmental issues has motivated companies to voluntarily disclose information about social and environmental issues, in order to demonstrate their responsibility towards environmental issue environment and community Research by Brown and Deegan (1998), Deegan and Rankin (1996), Deegan and Gordon (1996), Gray, Walters, Bebbington, and Thompson (1995), and Patten (1992) confirms this Disclosure of this information can be understood as a way to enhance a company's image or reduce social pressure from stakeholders (Deegan & Gordon, 1996; Deegan, Rankin, & Tobin, 2002) Increased environmental disclosure is not only driven by public or regulatory pressure, but also by the need to improve image and reputation with customers, regulators, investors and the community at large (Adams, 2002)
According to Peter S Rose (2004), a commercial bank is a business corporation organized for the purpose of maximizing shareholder value with an acceptable level of risk This requires banks to constantly seek new opportunities for growth, improve operational efficiency, planning and control efficiency From this perspective, a commercial bank can also be considered a business corporation, operating with the goal of maximizing profits with an allowed level of risk
Voluntary disclosure of environmental information aims to convey information to shareholders (Li et al., 1997; Bewley & Li, 2000) Companies use environmental information as a way to communicate their environmental strategies to shareholders (Clarkson et al., 2008) Voluntary theory suggests that companies voluntarily disclose information on social and environmental issues to improve their image and reputation Disclosure of information on climate-related financial risk management can be seen as a way for companies to demonstrate their commitment to environmental protection and social responsibility, creating long-term benefits for them in building relationships with stakeholders
Stakeholder theory suggests that organizations have a responsibility to manage conflicting interests among various parties by striving for an optimal balance (Pesqueux & Damak-Ayadi, 2005) By effectively managing relationships with stakeholders, businesses can attain long-term sustainable success (Freeman et al., 2010) From this perspective, banks prioritize the satisfaction of stakeholders, particularly depositors, and provide robust support to safeguard their funds and uphold stakeholder interests in banking products and services (Birindelli et al., 2018) This theory advocates for the utilization of internal management tools focusing on strategies aimed at achieving primary non-financial objectives, thereby enhancing social welfare and environmental conditions (Peng & Isa, 2020) Stakeholder theory emphasizes managing relationships with stakeholders and balancing conflicting interests Disclosure of information on climate-related financial risk management can be viewed as a way for companies to manage relationships with stakeholders, meet their expectations, and enhance satisfaction and trust from stakeholders.
FRAMEWORK FOR MANAGEMENT CLIMATE-RELATED FINANCIAL
The Basel Committee serves as the primary global authority for establishing standards governing the prudent regulation of banks and serves as a platform for collaboration on matters related to banking supervision Its objective is to reinforce the regulation, supervision, and operational standards of banks worldwide in order to bolster financial stability
Access to consistent, comparable, reliable, and understandable risk information has become increasingly crucial for creditors and investors To address this growing demand, several standards for climate-related disclosure have been established However, these standards primarily focus on disclosing information related to climate impacts, such as greenhouse gas emissions Users of such disclosures often highlight the absence of information regarding the financial implications of an organization's climate-related activities as a significant gap
The Committee has developed a separate set of consultation documents tailored specifically for the banking industry, distinct from the general industry guidelines provided by TCFD This specific guidance for the banking sector aims to enhance transparency regarding banks' risk exposure across various sectors and assists users in evaluating their banks' sensitivity to the transition towards a low-carbon economy While the disclosure recommendations are voluntary, they serve as guidance for investors, lenders, insurance underwriters, and other stakeholders BCBS is used by many central banks as well as the IMF and World Bank (Kandrács, 2019) Besides, according to Adrian et al (2023), the importance of institutions for effective banking supervision has been widely recognized through the acceptance of the core principles of banking supervision of BCBS (2012) In Vietnam, Decision No 986/QD-TTg of the Prime Minister dated August 8, 2018 requires that by the end of 2025, banking inspection and supervision must comply with most effective banking supervision principles results according to Basel Therefore, this study uses the supervisory framework of BCBS (2022) as the objective to evaluate the climate change related financial risk supervisory framework of the banking system in Vietnam
In June 2022, BCBS issued 12 governance principles (1-12) that banks must implement and 06 supervision principles (13-18) in which supervisory agencies need to manage to minimize climate-related financial risks (BCBS, 2022) Important contents related to legal activities are presented as follows:
Principle 1: The critical importance for banks to develop and execute a robust process for comprehending and evaluating the potential impacts of climate-related risk factors on their business operations and the environments they operate within
According to guidance from BCBS, Principle 1 emphasizes (1) reviewing significant climate-related financial risks across various timeframes; (2) integrating them into comprehensive business strategies and risk management frameworks; (3) the pivotal role of the Board of Directors and senior management in this process; and (4) ensuring clear communication of this approach throughout the organization Specifically, banks must consider both physical and transition risks when crafting their business strategies This involves assessing how these risks could affect the resilience of the bank's business model in the short, medium, and long terms, as well as their impact on achieving the bank's objectives Furthermore, banks should evaluate their sensitivity to structural changes in the economy, financial system, and competitive landscape due to climate-related risk factors The involvement of the Board of Directors and senior management is crucial at various stages of this process, and the approach established by the Board must be effectively conveyed to managers and employees throughout the organization Moreover, BCBS recommends that the
Board of Directors and senior management assess whether integrating significant climate-related financial risks into the bank's overall business strategy and risk management framework may require adjustments to compensation policies Finally, banks should ensure consistency between their risk management framework and stated goals This necessitates aligning internal strategies and risk acceptance statements with any climate-related strategies and commitments communicated publicly
Principle 2 - Supervision and Participation Responsibilities of the Board of Directors and Senior Management
According to the consultative document of BCBS, Principle 2 emphasizes the importance of the board of directors and senior management in assigning and supervising climate-related responsibilities within the organizational structure Banks need to ensure the enforcement of climate-related financial risk management responsibilities by clearly assigning them to board members and/or committees to ensure these risks are adequately considered in the bank's business strategy and risk management framework Moreover, the board of directors and senior management must possess sufficient understanding of climate-related financial risks, and the senior management must have the necessary skills and experience to manage these risks Banks should develop training programs and capacity-building initiatives, internally or through partnerships with expert organizations, as necessary BCBS recommends that the roles and responsibilities related to identifying and managing climate-related financial risks be clearly defined within the bank's organizational structure Relevant functions and business units should be equipped with adequate resources and expertise to effectively fulfill these responsibilities If dedicated climate units are established, their responsibilities and interactions with existing governance structures need to be clearly outlined
To adhere to Principle 2, banks should (1) clearly assign climate-related responsibilities, (2) ensure adequate understanding and skills within the board of directors and senior management, and (3) clearly delineate roles and responsibilities throughout the organizational structure to effectively manage climate-related financial risks
Principle 3 - Consistent Implementation of Appropriate Policies, Procedures, and Controls Throughout the Organization
Banks should apply appropriate policies, procedures, and controls consistently across the entire organization to ensure effective management of climate-related financial risks Managing significant climate-related financial risks must be integrated into policies, procedures, and controls across all functional departments and relevant business units, including activities such as customer onboarding and transaction evaluation
Principle 4 - Integrating Climate-Related Financial Risks into Three Lines of Defense Framework
Banks should integrate climate-related financial risks into their internal control framework across three lines of defense to ensure the identification, measurement, and mitigation of these risks in a reasonable, comprehensive, and effective manner Specifically, the internal control framework must include clearly defined responsibilities related to climate-related risks as well as reporting lines across the three lines of defense BCBS has outlined key focuses and considerations within the three lines of defense model for banks:
First Line of Defense: During customer onboarding, credit application, credit review, as well as ongoing monitoring and engagement with customers, risks related to climate should be assessed Employees here need to have full awareness and understanding of potential climate-related financial risks
Second Line of Defense: The risk management function should independently assess and monitor climate-related risks separate from the first line of defense The compliance function must ensure adherence to current rules and regulations
Third Line of Defense: The internal audit function should provide independent assessment and ensure objectivity regarding the overall internal control framework, all three lines of defense, and risk control framework amidst changes in methodologies, business operations, risk profiles, and the quality of underlying data
Principle 5 - Identifying and Quantifying Climate-Related Financial Risks and Integrating Them into Internal Assessment Processes
As per BCBS guidelines, banks are required to identify and quantify climate- related financial risks and integrate significant risks into their internal assessment processes for liquidity and capital adequacy, including appropriate stress testing programs Specifically, banks should (1) establish procedures to assess the impact of climate-related financial risks on their capital planning, incorporating significant risks into their internal capital adequacy assessment process Banks should evaluate whether climate-related financial risks could lead to cash outflows or deplete liquidity buffers under both normal business conditions and stressful scenarios Importantly, banks (2) must integrate climate-related financial risks, along with physical and transitional risks related to their business models, risk profiles, and business strategies, into their internal assessment processes for capital adequacy and liquidity Additionally, they should (3) assess these risks in stress testing programs to evaluate the financial recovery capability of banks in severe potential situations BCBS acknowledges that climate-related financial risks may evolve and increase over time as analysis methods and data improve Therefore, banks should (4) start building risk analysis capabilities by identifying related risk factors, developing risk metrics to quantify exposure levels, and evaluating the relationship between climate-related financial risks and traditional financial risks such as credit and liquidity
Principle 6 - Ensuring Comprehensive Management of Climate-related Financial Risks
EMPIRICAL EVIDENCES ON CLIMATE CHANGE RELATED FINANCIAL
To gain comprehensive understanding, the author referenced relevant prior research articles
According to a scientific journal titled "A New Framework for Assessing Climate Change Risks in Financial Markets" (Alvare et al., 2020), the authors meticulously identified and carefully examined various classifications of financial markets and climate-related risks They delved into operational risks, market structure, and market regulations within a new framework to describe the overall impact of climate change risks on financial markets and systemic risks These factors advocate for a modified framework to address climate-induced changes, contrasting with adhering to conventional financial, operational, and climate frameworks separately Another notable study titled "Precautionary Climate-Related Risks in the Banking Sector: Assessing Emerging Management and Supervisory Measures" (Feridun et al., 2020), scrutinized monitoring activities and the development of regulations related to the emergence of climate-induced safety risks in the banking sector The authors evaluated considerations regarding climate-related financial risks in the banking sector, conducted extensive reviews of relevant academic literature, and analyzed policy publications from various regulatory agencies This study also highlights the significance for banks and banking regulatory agencies in different legal jurisdictions, guiding them to identify necessary actions to address climate change risks in the banking sector
Additionally, in Vietnam, there have been two scientific articles addressing this topic The first one, "Financial Risks Related to Climate Change - Recommendations for Vietnamese Commercial Banks" (Vo Thi Kieu Oanh, 2023), provides an overview of financial risks related to climate change, systemic impacts, and proposes additional recommendations for Vietnamese commercial banks The second scientific article,
"Climate Risk Monitoring at the European Central Bank and Recommendations for Vietnam" (Ha Thi Thieu Dao & Nguyen Thi Quy, 2023), analyzes the transmission channels of climate-related risks, transitioning from physical risks to systemic risks in the financial system It also explores actions taken by central banks in European countries to cope with these risks Consequently, the article provides policy recommendations for Vietnam in financial monitoring against the impacts of climate change Overall, these two scientific articles offer a comprehensive overview of theories related to financial risks associated with climate change and propose policy- building solutions, directing operational guidelines for the SVB However, they do not delve into internal operational issues of commercial banks
Currently, the frameworks for monitoring financial risks related to climate change are commonly issued by BCBS, FSB, NGFS In addition, central banks and financial regulatory agencies in the world increasingly recognize that climate change has significant implications for the financial stability of the banking system Central banks worldwide have different responses to climate-related financial risks
The Bank of England (BoE) was the first central bank in the UK to pay attention to financial risks related to climate change, starting in 2014 The report of the Bank of England on the impact of climate change on the insurance sector of the UK was published on September 29, 2015 They confirms that managing climate-related risks is part of its statutory duty The Bank of England (BoE) has released “the Bank of
England Climate Disclosure 2023”, which includes scenario analysis for assessing financial risk across all three asset classes (BoE, 2024)
The central bank of Canada (BoC) and the Office of the Superintendent of Financial Institutions (OSFI) have issued guidance reports and the results of scenario analysis of climate-related risks for six financial institutions in Canada, emphasizes potential macroeconomic impacts, including changes in domestic and international policies affecting the Canadian economy, as well as the impact of global climate policy changes on capital exports and commodities Besides, BoC released “Bank of Canada Disclosure of Climate-Related Risks 2022”, which establishes a foundation on which to build a comprehensive long-term strategy (BoC, 2023)
The Bank of Japan (BoJ) has established an internal network, the Climate Coordination Center, to enhance industry-wide banking initiatives on climate change
In the view of the BoJ, supporting private sector efforts on climate change from central banks will contribute to macroeconomic stability in the long run (BoJ, 2021) The European Central Bank (ECB) has conducted stress tests on the risk of climate change for 41 financial institutions in the European Union In the most difficult scenario, these organizations could face up to 70 billion euros in credit and market losses due to increased natural disasters and profound changes in economic sectors They have requested that banks intensify efforts to manage climate risks and adjust collateral asset policies to encourage less polluting activities (ECB, 2022)
To minimize the impact of climate-related risks on financial stability, financial regulatory agencies are increasingly requiring more climate risk assessments While financial losses and risks associated with climate change can harm many individuals and organizations, central banks and financial regulatory agencies are increasingly concerned about the impact on the financial sector If climate risks are not effectively managed, banks may suffer serious financial losses and reputational damage However, if banks take proactive steps to manage climate risks, they will not only reduce risks but also contribute to a sustainable future Exemplary studies show that many banks are taking specific steps to effectively manage climate risks, including integrating climate risks into their overall risk management frameworks, developing climate risk management tools, and controlling influencing factors.
CURRENT STATUS ON CLIMATE-RELATED FINANCIAL
LEGAL REGULATIONS FROM THE STATE BANK OF VIETNAM
The SBV has also issued Circular No 17/2022/TT-NHNN dated December 23,
2022, providing guidelines for environmental risk management in the credit granting activities of credit institutions This mandates credit institutions to assess and manage credit risks associated with the environment during the lending process and develop internal regulations to implement environmental risk management Circular No 39/2016/TT-NHNN dated December 30, 2016, concerning lending activities of credit institutions, sets forth requirements for lending activities to comply with environmental protection laws (Box 3.1)
As a vital financial channel for the economy, the banking sector is acutely aware of its significant responsibility in promoting sustainable investment The issuance of Circular No 17 by the State Bank of Vietnam (SBV) serves as clear evidence of this organization's commitment to environmental protection This directive specifically aims to enhance the risk management capabilities of financial institutions facing environmental and climate-related risks Such action reflects the increasing trend of financial institutions aligning with international standards and norms regarding sustainable finance SBV's concrete steps in managing climate change risks within banking operations have provided clearer direction for commercial banks under its supervision in managing these risks effectively
Box 3.1: Instructions and regulations of the SBV
Source: Synthesized by the author
Circular No 17/2022/TT-NHNN dated December 23, 2022:
Article 4, Clause 2: Environmental Risk Management Principles in Credit Granting Activities
Credit institutions conduct environmental risk assessment in credit granting activities for investment projects to identify credit risks, determine credit granting conditions, and manage credit risks for credit disbursement
Article 6, Clause 1: Internal Regulations on Environmental Risk Management in Credit Granting Activities
Credit institutions establish internal regulations for environmental risk management in credit granting activities, either independently or integrated within internal regulations on credit granting and internal control, in accordance with legal provisions on credit activities and credit risk management
Environmental risk management in credit granting activities is carried out during credit examination, appraisal, approval, and management
Circular No 39/2016/TT-NHNN dated December 30, 2016:
Article 4, Clause 1: Principles of Lending and Loaning
Lending activities of credit institutions with customers are conducted based on agreements between credit institutions and customers, complying with the provisions of this Circular and relevant legal regulations, including environmental protection laws.
CONCLUSIONS AND RECOMMENDATIONS
CONCLUSIONS
Climate change is a complex and unpredictable phenomenon The study has introduced and defined climate-related financial risks, factors influencing banks' disclosure practices, and provided an overview of management frameworks from the BCBS Additionally, the research conducted observations with 27 joint-stock commercial banks in Vietnam during the period of 2020 to 2023, utilizing information from annual reports, sustainable development reports, and publicly available data In the context of Vietnam being vulnerable to severe climate change events and the government's commitment to the United Nations Framework Convention on Climate Change (COP28), the disclosure of information and the management of environmental financial risks in credit activities specifically, and banking operations in general, are essential
A survey conducted by the regulatory body in the UK has shown that merely 10% of banks have implemented a comprehensive and strategic approach to addressing climate change (BoE, 2021) This finding holds particular significance given the pivotal role banks play as major providers of financing for transitioning, especially for small and medium-sized enterprises that lack access to international capital markets According to a study on McKinsey (2020), an analysis of the loan portfolios of 46 European banks revealed that approximately 15% of these portfolios are exposed to heightened risks stemming from climate change, predominantly in sectors such as electricity, gas, mining, water supply, transportation, and construction, which face substantial transition risks
The interconnection between the banking and insurance sectors can propagate financial risks related to climate change from one area to another, leading to larger systemic issues Therefore, in Vietnam, implementing and establishing an internal financial risk management system related to climate change, as well as disclosing climate-related financial risks by commercial banks, is imperative Although the level of implementation varies among banks, this shows promising signs of awareness among commercial banks regarding the climate-related risks affecting their operations In addition to the points mentioned, it can be observed that managing financial risks associated with climate change is not solely the responsibility of commercial banks but of the entire financial system Collaboration among banks, insurance organizations, regulatory agencies, and the government is necessary to ensure that solutions are implemented effectively and comprehensively.
RECOMMENDATIONS
The inadequacy and delay in identifying, measuring, and managing transition risks and physical risks associated with climate change will have adverse effects on the safety and sustainability of both the bank and the entire financial system To effectively manage climate-related financial risks, research suggests that commercial banks should implement the following key recommendations:
Firstly, integrate climate financial risks with other significant risks Feridun & Gỹngửr (2020) highlight that monitoring climate financial risks individually may not be highly effective due to their significant impact Therefore, it is essential to incorporate climate financial risk considerations into all aspects of risk management, including capital allocation, loan approval, investment portfolio monitoring, and reporting For example, commercial banks can merge climate maps with their credit rating maps This integration helps bank executives identify credit allocations in high climate risk areas and make necessary adjustments to minimize risks associated with regions prone to climate
Secondly, clarify the responsibility of senior management in climate financial risk management at commercial banks Allocating senior management positions with tasks related to implementing and managing climate financial risks is a necessary regulation reflecting the importance of climate financial risks in banking operations This regulation enhances senior management's awareness of climate financial risks, thereby improving the effectiveness of climate financial risk management and monitoring at the unit level Internal regulations on climate financial risk monitoring create a distinct legal framework within each unit, enhancing clarity, transparency, and consistency in risk monitoring This also serves as a basis for evaluating the role of individuals assigned to supervise climate financial risks and activities within commercial banks
Thirdly, identify potential threats and adjust business and credit strategies
Climate considerations need to be incorporated into risk and capital allocation processes Many organizations have decided not to finance certain companies or sectors or have set emission thresholds to finance specific sectors Therefore, the board of directors should regularly identify potential threats to strategic plans and business models (Eceiza et al., 2020)
Fouthly, conduct climate financial risk resilience assessments According to
BCBS guidelines, commercial banks should regularly conduct scenario analysis and assess the resilience of climate financial risks as it is a critical factor in evaluating their recovery ability To conduct risk resilience assessments, banks need to first identify significant climate hazards and primary risk factors by sector, analyze to produce physical risk and transition risk scenarios Subsequently, this helps banks estimate the extent of damage from weather events such as droughts, heatwaves, etc Lastly, banks must quantify these impacts on each counterpart and aggregate based on the investment portfolio to devise appropriate risk mitigation measures
Fifthly, reference international standards for environmental risk reporting from international organizations In the process of developing legal frameworks, commercial banks can refer to reporting standards on the environment issued by international organizations such as BIS, TCDF At the same time, the disclosed information must meet the standards of consistency, comparability, detail, and reliability
Sixthly, identifying green credit activities, green banking is a trend, requiring a shift towards sustainable development This involves integrating green development into the orientation and business strategy planning of financial institutions; training specialized human resources in environmental matters; researching and developing diverse banking products and services to meet green credit requirements; and mobilizing green finance Diversifying funding sources for green projects, especially through issuing green bonds in the domestic capital market, is also essential
Seventhly, credit policies need to be implemented coherently with climate policies to contribute to climate risk mitigation Segregating financial instruments to combat climate change alone will not suffice for long-term financial stability Regulatory policies on fiscal, industrial, and environmental matters play a crucial role, and policy coordination is necessary Such coordination can lead to more significant emission reductions and minimize some of the climate transition impacts
Eighthly, consistent implementation of appropriate policies, procedures, and controls Throughout the commercial banks should develop and implement policies, procedures, and controls to manage climate-related financial risks consistently across all departments and business units This includes integrating these considerations into the customer evaluation process and transaction approval procedures Additionally, continuous training programs for employees are essential to ensure they understand and can effectively apply these policies, procedures, and controls Such measures will help ensure that the management of climate-related financial risks is ingrained in the organization's culture and operational practices
Ninethly, integrating climate-eelated financial risks into the three lines of defense model Banks should clearly define responsibilities related to climate-related financial risks and establish reporting lines across the three lines of defense The first line of defense should focus on identifying and managing risks during the customer due diligence process and continuous monitoring The second line of defense should independently assess and monitor climate-related risks, ensuring compliance with current regulations The third line of defense should provide an independent assessment of the entire internal control framework, ensuring objectivity in risk control This comprehensive approach ensures that climate-related financial risks are managed effectively across all levels of the organization
Tenthly, understanding and managing climate-related liquidity risks Banks need to assess the impact of climate-related risk factors on their liquidity risk profiles, including cash flow and the value of assets in their liquidity buffers When necessary, banks should adjust their liquidity buffers and integrate these factors into their liquidity risk management frameworks Additionally, banks should prepare climate- related stress scenarios to test their resilience against climate emergencies, ensuring they have sufficient liquidity to withstand challenging times
Eleventhly, the SBV has sanctions and controls regarding the operations and implementation of commercial banks under Circular No 35/2015/TT-NHNN on regulations on statistical reports applicable to credit institutions and branches of foreign banks, and Form No 005.H/BCB-NHNN on reporting Credit Balances of credit institutions, foreign bank branches by economic sector The lack of consistency among banks in setting up reports and statistical data has created obstacles for policymakers in commercial banks to implement measures to promote green growth
Finally, the recommendation is for the SBV to issue guidance on classifying the Green List and criteria for identifying green projects suitable for Vietnam's economic sectors This will provide the basis for commercial banks to assess, evaluate, and monitor green credit issuance The Green List classification is essential for the SBV to evaluate the effectiveness of policies and solutions in credit policies that contribute to achieving the national green growth target It also serves as a critical basis for financial institutions to determine investment levels, scale, and deploy appropriate banking policies, products, and services.
LIMITATIONS AND FUTURE RESEARCH
The outcomes of this study offer a broad perspective on the environmental financial risk landscape and the current practices of commercial banks in Vietnam regarding risk management It also examines the underlying theories influencing the disclosure of environmental financial risks by these banks Despite its accomplishments, the study faces several limitations
Firstly, a scarcity of data and information concerning both temporal and spatial dimensions As policies and guidelines are still in their early stages of implementation, there is inconsistency and a lack of coherence in information disclosure due to the absence of specific directives from the SBV In the future, the study could broaden its scope by investigating additional factors influencing information reporting and environmental risk management implementation, particularly with the availability of more data over time, enabling comparisons among commercial banks in Vietnam and internationally
Secondly, in line with the guidance of SBV, Circular No 17/2022/TT-NHNN mandates credit institutions to assess and manage environmental credit risks during lending processes and develop internal regulations accordingly The issuance of the Principles for the Effective Management and Supervision of Climate-Related Financial Risks by the BCBS further reinforces this requirement In the future, as environmental financial risk information databases expand, the theoretical framework established in this research will contribute to filling gaps for subsequent studies
In this chapter, the author draws conclusions from the information gathered and analyzed from the results of chapter 3, thereby providing recommendations and proposals for enhancing information disclosure and climate financial risk management policies for commercial banks The contributions of the study can offer a more comprehensive outlook on the development of climate financial risks for commercial banks in Vietnam in the future The SBV and the government issue important policies and guidelines to provide direction and specific regulations for commercial banks to adhere to.
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