Climate Risk Assessment - Global and Vietnam context

- Transition risk refers to the financial loss an organization may incur directly or indirectly from the adjustment process towards a lower-carbon and environmentally sustainable economy. This can be caused by, for example, the sudden adoption of climate and environmental policies, technological advancements, or changes in market sentiment and preferences.

Why does it matter?

Climate and environmental risks are not a new, isolated category of risk. In reality, they act as drivers that exacerbate the traditional risk categories of the financial system. Climate change is now recognized as a risk to financial stability, as financial institutions begin to report actual losses from extreme weather events, an increase in non-performing loans, and a decline in collateral asset values. These impacts are not just short-term, but also profoundly affect the resilience of business models in the medium and long term, especially for institutions whose investment portfolios are concentrated in environmentally sensitive sectors.

In core operations, climate risk directly affects credit quality by reducing customers' ability to repay debt and depreciating collateral assets. For example, physical phenomena like floods or major storms can cause severe damage to assets and production activities, leading to a sharp increase in non-performing loans (NPLs) and forcing banks to increase provisions for loan losses. From a transition perspective, tightening policies on emissions or sudden shifts in market sentiment can cause the value of fossil fuel-related assets to plummet, potentially becoming "stranded assets." This compels financial institutions to re-examine their strategies and risk appetite more cautiously.

Furthermore, issues of operational disruption and reputation are challenges that cannot be overlooked. Extreme climate events have the potential to damage physical infrastructure such as bank branches, ATM systems, or data centers, interrupting the ability to provide continuous service. At the same time, financial institutions also face legal liability risks from environmental-related claims and reputational risk if they are perceived by the public as irresponsible in the green transition. In a context where global investors and regulators increasingly demand higher transparency, understanding and effectively managing climate risk is not just a compliance task but a vital factor in ensuring the sustainable development of every financial institution today.

Global implementation trends

The global trend in climate risk management is shifting strongly from voluntary activities to mandatory and highly systemic legal frameworks.

Leading this effort is the European Central Bank (ECB), which issued a guide in November 2020, setting out 13 specific expectations for governance, strategy, and risk management for financial institutions. Not only stopping at issuing documents, supervisory agencies such as the Bank of England (BoE) or the Monetary Authority of Singapore (MAS) have begun requiring banks to conduct regular scenario analysis and stress tests to measure the resilience of the system to environmental shocks. These standards focus on integrating climate risk into all aspects of credit risk, market risk, and liquidity, rather than just viewing it as a conventional social responsibility issue.
In Asia, from Hong Kong to Malaysia, the adoption of risk modeling and green transition roadmaps is also becoming mandatory requirements, reflecting the common expectation of global investors and regulators for transparency and readiness for the challenges of climate change.

Current Status and Roadmap for Climate Risk Management in Vietnam

In Vietnam, the roadmap for climate risk management is at a critical juncture as banks gradually transition from complying with traditional capital adequacy rules to modern sustainability standards. Currently, Basel II still serves as the primary "code of conduct," helping banks ensure sufficient capital to withstand common risks, while stricter standards from Basel III are beginning to emerge as a solution to make the financial system more resilient to unexpected market volatility. Although the State Bank of Vietnam has provided strategic guidance through the Green Banking Action Plan 2021 - 2030, practical implementation has not been systematically formalized.
A significant current obstacle is the scarcity of climate data, partly because international reporting standards like IFRS S1 and S2, which require banks to transparently disclose environmental risks in their financial reports, are not yet mandatory in the Vietnamese market. This creates a gap in accurately quantifying risk. However, this context opens up a great opportunity for Vietnam to achieve two goals with one arrow: both upgrading the system to advanced governance standards and integrating climate risk into operational processes. Proactively assessing and managing risk now will not only help banks anticipate future regulations but also affirm their credibility with international investors regarding a sustainable and transparent development vision.

- Minh Hung -