## 1islea2023005 ## Source details **Canonical URL:** [1islea2023005](https://www.imf.org/-/media/files/publications/cr/2023/english/1islea2023005.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1islea2023005.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1islea2023005.pdf.json) --- ### Major findings on Iceland’s climate-related financial risks and institutional context - Iceland is exposed to volcanic eruptions, extreme weather, sea acidification, and melting glaciers, and to transition risks affecting sectors like fisheries and transportation. - Abundant domestically produced renewable energies cover nearly all the country’s heat and electricity production needs. - The 2020 Climate Action Plan and the 2021 Iceland’s Strategy on Adaptation to Climate Change include ambitious objectives toward GHG emissions’ neutrality. - Coordination between the Central Bank of Iceland (CBI) and ministries/public agencies implementing climate policy is limited; the financial sector deserves greater scrutiny given its potential exposure and role as contributor to the Plan. - The CBI has a legal mandate on financial stability and financial supervision that applies to climate-related financial risks and should be involved in governmental coordination and cooperation arrangements on climate change issues. - Standard setters (BCBS, FSB, ISSB) are still developing international standards on climate-related financial risks applicable to the banking sector; EU/EBA regulations on ESG are not yet stabilized nor fully applicable in Iceland. - Icelandic banks’ exposure to climate-related financial risks cannot be precisely assessed due to significant data gaps while the regulatory framework is under construction; no global risk assessment combining quantitative and qualitative inputs has been performed so far. - Progress made: enhanced Basel Pillar 3 financial disclosure on ESG in 2022; sectoral exposures (e.g., fisheries) have been highlighted in public information. - The CBI faces serious issues collecting relevant bank data needed to assess exposures to physical and transition risks; data quality and availability are preconditions for effective supervision across banks, insurance companies, and pension funds. - The CBI should not wait for finalized EU/EBA regulations; it should enhance data availability and collect more comprehensive, granular, and risk-based data on physical and transition risks to inform supervisory action. - The CBI considers sustainable finance a strategic priority for financial supervision in 2022–24 but has not yet adopted a formal strategic roadmap or structured internal project management framework to implement effective supervision of climate-related financial risks. - By mid-March 2023, staffing on climate issues consisted of one macroprudential specialist and one climate risk specialist working part-time within Financial Stability and Prudential Supervision, respectively. - Commendable analytical work includes a first supervisory scenario analysis on the impact of climate-related credit risk on banks’ corporate credit portfolios (March 2023). - ESG risks were considered during the 2022 supervisory review and evaluation process (SREP) of Iceland’s three larger banks, including supervisory dialogue on business model analysis and corporate governance. - The CBI is a member of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) since 2020 and closely monitors EU/EBA developments and cooperates with Nordic peers. - Supervision intensity should be gradually increased following the 18 overarching Basel Committee principles (June 2022), once data quality has been enhanced. - Supervisory tasks should combine: (1) financial stability oversight (scenario analysis and stress testing), (2) microprudential supervision (governance, risk management, credit risk, capital and liquidity impact, business model adaptation, profitability drivers), and (3) conduct supervision (quality of Pillar 3 financial disclosure). - Icelandic banks have established sustainable finance units and enhanced “green” or “blue” profiles; disclosure alone is insufficient—banks must upgrade risk management processes to assess exposures and impacts on prudential capital and liquidity. - The CBI should support banks’ upgrades through supervisory dialogue, offsite surveillance, targeted onsite inspections, and urgent focus on ensuring reliable and relevant climate-related data production and regulatory reporting by banks. - The CBI should determine whether banks’ capital and liquidity buffers are adequate to cover climate-related financial risks and, if needed, decide additional capital and/or liquidity requirements on a case-by-case basis through informed assessment. ### Institutional recommendations and supervisory priorities - The CBI should be involved in government-level coordination on climate change and partner with stakeholders to improve production of climate-related data and refine financial supervision strategy. - The CBI should develop a structured internal project management framework, a clear but flexible and proportionate three- to five-year action plan, and objectively estimate any need for additional staff, expertise, tools, and budget. - Supervision should proceed on a risk-based and targeted basis, leveraging existing EU/EBA requirements while tailoring implementation to Iceland’s specific needs and using the principle of proportionality. ### Key statistics and time markers cited in the executive summary - CBI strategic priority horizon: 2022–24. - CBI NGFS membership since 2020. - Enhanced Basel Pillar 3 financial disclosure on ESG: 2022. - First supervisory scenario analysis on climate-related credit risk: March 2023. - Staffing as of mid-March 2023: one macroprudential specialist and one climate risk specialist working part-time on climate issues. ### Key recommendations (extracted from Table 1) - Recommendation 1: Produce a global assessment of climate-related financial risks within the financial sector (including banks) to identify actual and potential vulnerabilities. — Responsible: CBI — Priority: MT - Recommendation 2: Clarify the expected role and contribution of the CBI and the financial sector (including banks) to implement the 2020 Iceland’s Climate Action Plan and 2021 Iceland’s Strategy on Adaptation to Climate Change at the country level. — Responsible: CBI, MoFEA, MoEEC — Priority: NT - Recommendation 3: Enhance domestic cooperation of the CBI with relevant ministries and public agencies involved in climate change issues to develop synergies supporting effective and efficient supervision of climate-related financial risks within the financial sector (including banks), while safeguarding the supervisory independence of the CBI. — Responsible: CBI, MoFEA, MoEEC, Others — Priority: NT - Recommendation 4: Tailor the implementation of the EU/EBA regulatory framework considering Iceland’s specific climate change issues to ensure adequate and proportionate supervision of climate-related financial risks in the banking sector. — Responsible: CBI, MoFEA — Priority: MT - Recommendation 5: Specify a comprehensive CBI supervisory strategy, including a structured action plan, to build an adapted supervisory framework on climate-related financial risks within the financial sector (including banks). — Responsible: CBI — Priority: NT - Recommendation 6: Assess the need for additional CBI staff, expertise, tools, and budget to ensure appropriate supervision of climate-related financial risks within the financial sector (including banks). — Responsible: CBI — Priority: I - Recommendation 7: Enhance the CBI’s internal organizational framework for oversight and supervision of climate-related financial risks within the financial sector (including banks). — Responsible: CBI — Priority: NT - Recommendation 8: Develop supervisory assessment methodology, tools, and processes considering existing and future EBA requirements for climate-related financial risks within the banking sector. — Responsible: CBI — Priority: MT - Recommendation 9: Complete the development of adapted supervisory stress testing and scenario analysis on climate-related financial risks within the banking sector. — Responsible: CBI — Priority: MT - Recommendation 10: Bridge data gaps in climate-related financial risks within the banking sector (notably, adapt the collection of useful data by relevant public agencies). — Responsible: CBI, MoECC, Others — Priority: MT - Recommendation 11: Engage the banking sector in a more proactive and thorough supervisory dialogue to strengthen respective capacities of supervisors and banks to assess and manage climate-related financial risks. — Responsible: CBI — Priority: I - Recommendation 12: Disclose supervisory expectations to banks and provide guidance on implementation of corporate governance and risk management of climate-related financial risks. — Responsible: CBI — Priority: MT - Recommendation 13: Assess the impact of climate-related financial risks on banks’ business models and profitability drivers. — Responsible: CBI — Priority: MT - Recommendation 14: Assess the adequacy of banks’ corporate governance, internal organization and resources, capacity, and internal control of climate-related financial risks. — Responsible: CBI — Priority: MT - Recommendation 15: Assess the adequacy of banks’ risk management frameworks and processes for climate-related financial risks. — Responsible: CBI — Priority: MT ### 16. Assess banks’ data production and reporting processes for climate-related financial risks - Recommendation 16: Assess banks’ data production and reporting processes for climate-related financial risks and enhance supervisory data collection and analysis concomitantly. — Responsible: CBI — Priority: MT - Complementary recommendations: - Recommendation 21: Determine an action plan for effective implementation of EBA data disclosure and reporting standards — Responsible: CBI; MoFEA — Priority: NT - Recommendation 22: Develop regulatory reporting templates and key monitoring indicators of climate-related financial risks — Responsible: CBI — Priority: NT - Recommendation 24: Develop institutional supervisory disclosure by the CBI of relevant informative data and analysis — Responsible: CBI — Priority: MT - Recommendation 23: Ensure adequate financial disclosure of climate-related financial risks by banks — Responsible: CBI — Priority: MT - Rationale: - Progress hampered by data gaps, resource constraints, lack of harmonized methodologies, and lack of broadly agreed international standards. (Intro, Para 2) - IMF FSAP mission found a lack of official data on climate-related financial risks; analysis on banks’ exposure was limited and relied only on public information. (Para 6) - No public climate-related information specific to the financial sector was identified from official sources. (Para 14) - Operational assessment elements: - Evaluate banks’ internal data production processes: data sources, data governance, frequency and granularity. - Assess banks’ reporting readiness: alignment with EBA expectations, use of regulatory templates and indicators, financial statement disclosure practices. - Enhance supervisory collection and analytical capacity: develop supervisory templates and KRIs, build CBI disclosure capacity, integrate data collection with supervisory impact assessment of capital adequacy and liquidity (see Recommendation 20). - Expected outcomes: - Improved data quality and comparability across banks. - Enhanced supervisory stress testing and scenario analysis capacity. - More consistent public disclosure by banks and institutional supervisory disclosure by the CBI. - Progress toward aligning national practice with BCBS principles and evolving EU/EBA standards. ### 32. Produce a global assessment of climate-related financial risks within the financial sector - Strategic actions: - Produce a global assessment covering banks, insurance companies, and pension funds to identify vulnerabilities. - Clarify roles and contributions of the CBI and the financial sector to the 2020 Climate Action Plan and the 2021 Adaptation Strategy. - Enhance domestic cooperation between CBI and ministries/public agencies to coordinate data classification, production, and disclosure. - Tailor implementation of EU/EBA regulatory framework to Iceland, with explicit supervisory expectations for banks. - Specify a comprehensive CBI supervisory strategy with action plans, responsibilities, resources, and expected outcomes. - Assess and request additional staff, expertise, tools, and budget for a three- to five-year horizon. - Overview of banking sector exposure (limited illustration): - The chapter provides a limited quantitative illustration and does not measure banks’ vulnerabilities. - Data collection is ongoing and challenging; disclosure framework development will consider EU Taxonomy Regulation (to be transposed by the Icelandic Parliament in 2023) and future EBA guidelines. - Illustrative data points: - Commercial banks’ corporate credit portfolios (only loans above ISK 300 million) were composed of: 75 percent of “green” loans, 16 percent of “neutral” loans, 9 percent of “brown” loans (Credit Registry/Central Bank of Iceland database, March 2023 Financial Stability Report). - The CBI has not assessed the quality and reliability of bank-reported classifications to the Credit Registry. - Arion Banki reported a ratio of carbon-related assets to the total loan book of 37 percent (year-end 2022). - Banks disclosed financed CO2 emissions and sustainable asset metrics in various 2020–22 disclosures. - CBI scenario analysis and dashboard outputs: - CBI produced a first scenario analysis released on March 15, 2023 focused on credit risks in corporate loan portfolios using Credit Registry data. - CBI dashboards highlighted: sectoral emissions concentration; loan carbon intensity estimates; fisheries as high share of brown corporate loans; manufacture of food products as high share of neutral loans; green loans account for 75 percent of total corporate loans; results of three climate scenarios were evaluated. ### 50. Regulatory requirements for banks’ financial disclosure have been enhanced since 2022 - Pillar 3 and EBA requirements: - Annual Pillar 3 reports should comply with EU Regulation 2021/637 (amended in 2022 to include ESG risks) and present standardized tables and templates. - EBA asks banks to disclose climate risks, mitigating actions, GAR and BTAR, ESG strategies, governance, and risk management arrangements. - EBA expects reliable data for the GAR from December 2023 for counterparties subject to NFRD and on the BTAR for June 2024. - Icelandic implementation and supervisory status: - The CBI has not yet assessed banks’ 2022 Pillar 3 reports; assessments are planned as a first concrete supervisory task. - The CBI has not issued specific regulatory reporting requirements or templates for climate-related financial risks. - The Annual Accounts Act recently requires certain entities to include discussion of environmental, social, and human resources in annual reports. - Larger banks started publishing ESG reports in 2022; CBI supervisors have not yet assessed alignment with EBA expectations. - Supervisory reporting gaps: - No regulatory templates for periodic standardized reporting or ad hoc reporting on climate-related risks. - Use of KRIs/KPIs for climate-related financial risks is not yet part of supervisory processes. - CBI has not adopted guidance for calculation of KRIs/KPIs such as the GAR, which will come into force by end-2023. - CBI public disclosure: - CBI published official statements of commitment, the 2021 sustainability report, the 2022–24 supervisory strategy, and a box on climate-related credit risk in the 2023/1 Financial Stability Report. - Public information and quantitative data on banks’ risk exposure and management is limited. - Key findings on supervisory capacity: - CBI has an adequate legal mandate (Act No. 161/2002; Act No. 87/1998) to oversee climate-related financial risks. - Strategic planning is barely structured; no formal strategic action plan has been designed or endorsed by supervisory committees. - Organizational adaptations made but interdepartmental cooperation remains informal. - By mid-March 2023, only two CBI specialists had relevant expertise; a new climate expert was hired by end-March 2023. - The CBI has not estimated multiyear staffing and budget needs for the next three to five years. - Recommendations (selected): - Determine an action plan for effective implementation of EBA data disclosure and reporting standards. - Develop regulatory reporting templates and KRIs/KPIs for supervisory purposes. - Ensure adequate financial disclosure by banks, insurance companies, and pension funds. - Develop institutional supervisory disclosure by the CBI of aggregated data, KRIs/KPIs, supervisory stress test results, and supervisory analysis. ### 66. Supervisory expectations on management of climate-related financial risks - Status of supervisory expectations and communication: - By March 2023, the CBI had not disclosed supervisory expectations tailored to Iceland for risk management and disclosure of climate-related financial risks. - Institutional communication (public guidance or outreach events) had not started. - Supervisory tools and scenario analysis: - CBI is at a preliminary stage of creating procedures, IT tools, databases, and assessment methodology. - CBI implemented a first top-down climate scenario analysis (published March 2023) focused on corporate credit portfolios using Credit Registry data. - CBI plans to expand to other risk types and conduct bottom-up exercises in cooperation with banks, draw on NGFS and ESRB/ECB approaches, and explore data sources (e.g., NiGEM, QMM). - Climate-related stress testing is not yet used to assess adequacy of solvency and liquidity buffers; CBI intends by end-2023 to enforce a new law on disclosure of sustainability and taxonomy for sustainable finance (planned parliamentary adoption mid-2023). - Prudential supervisory expectations (Principles excerpts): - Principle 13–15: Supervisors should ensure banks incorporate climate-related risks into business strategies, governance, internal controls, and risk management, and apply scenario analysis where appropriate. - Governance, risk management, and controls findings: - First discussions on governance occurred during 2022 SREP; CBI has not yet thoroughly assessed board/senior management integration of climate-related risk drivers. - Banks have set up sustainability committees and policies; CBI plans to assess adequacy during 2023 SREP. - Limited supervisory evidence that banks have included climate-related risks in internal control frameworks and internal audit. - Capital and liquidity adequacy: - Principle 5: Banks should incorporate material climate-related risks into ICAAP and ILAAP and stress testing; supervisory assessment and implementation remain to be completed. ### 83. Impact assessment process on banks’ solvency, liquidity, and risk management - Solvency and ICAAP: - 83: The impact assessment process of climate-related financial risks on banks’ solvency has not yet matured. - 83: The CBI indicated banks are not yet explicitly required to include climate-related financial risks in their ICAAP. - 83: Banks have started to incorporate solvency impact assessment into internal stress testing and ICAAP but typically do not quantify the impact on capital. - 83: The materiality of potential additional capital needs from climate-related risks has not been assessed over near- to long-term horizons. - Liquidity and ILAAP: - 84: Impact assessment on banks’ liquidity has not been developed; banks are not yet explicitly required to include climate-related financial risks in ILAAP. - 84: The CBI cannot assess whether climate-related financial risks could cause net cash outflows or depletion of liquidity buffers under stress. - Development of risk analysis and stress testing: - 85: Banks’ capabilities are being developed; EBA guidance EBA/REP/2021/18 not yet legally enforced in Iceland. - 88–89: Banks’ data collection and aggregation processes have not been assessed; lack of data is a major hindrance. - 99: Internal scenario analysis not yet a requirement; CBI plans bottom-up analysis in cooperation with banks. - Risk management frameworks: - 86: Banks’ risk management frameworks for climate-related risks have not undergone supervisory assessment; no specific legal requirements yet. - 97–98: Specific supervisory requirements on climate-related operational risk are not yet applicable; banks’ business continuity plans consider climate threats and the Natural Catastrophe Fund is a key mitigating role. - Credit, market, liquidity risk management: - 90: EBA loan origination and monitoring guidelines cover ESG but provisions specific to climate-related risks are less explicit. - 91–92: Banks’ adjustment of credit risk management has not been assessed; climate-related credit risk exposure cannot be clearly measured yet. - 93–94: No specific supervisory guidance on climate-related market risk; global market exposure of Icelandic banks is limited. - 95–96: No specific supervisory guidance on climate-related liquidity and funding risks; green bond issuance by banks is at an early stage and pricing effects warrant monitoring. - Key supervisory recommendations (paragraphs 100–104): - 100: Enhance CBI internal organizational framework and clarify roles across departments; consider internal steering committee and climate focal point. - 101: Develop supervisory assessment methodology, tools, and processes tailored to Iceland and mitigate key-person risk. - 102: Refine supervisory stress testing and scenario analysis using NGFS and EBA scenarios, tailoring to Iceland’s drivers. - 103: Bridge data gaps; determine required banking data for scenario analysis and supervision, prioritize KPIs/KRIs. - 104: Engage banking sector in proactive supervisory dialogue and set up institutional communication policy. ### 105. Disclose supervisory expectations and provide guidance; assess impacts - Disclosure and guidance: - Disclose supervisory expectations to banks and provide guidance on implementation, corporate governance, and risk management of climate-related financial risks. - Targeted and proportionate national guidance is useful in addition to EU/EBA regulations. - Assess business model and profitability impacts: - Assess the impact of climate-related financial risks on banks’ business models and profitability drivers as a medium- to long-term objective, requiring reliable data and supervisory assessment. - Corporate governance and resources: - Assess adequacy of banks’ corporate governance, internal organization, resources, capacity, and internal control for climate-related financial risks. - Seek evidence of effective frameworks and adequate staffing, at least within larger banks, to order preventive or corrective action if needed. - Risk management frameworks: - Assess adequacy of banks’ risk management frameworks and processes; monitor progressive construction and capacity development. - Data and reporting: - Assess banks’ data production and reporting processes and enhance supervisory data collection and analysis concomitantly. - Once data requirements are clarified, the CBI should assess implementation of reliable frameworks for climate data production, quality control, and regulatory reporting. - Credit, market, liquidity, operational risks: - Assess impact of climate-related drivers on credit risk and adequacy of adjusted credit risk management and mitigation techniques. - Prioritize assessment of liquidity risk exposures due to climate-related financial risks and evaluate impact on long-term funding strategy. - Ensure climate-related drivers are incorporated into operational risk management beyond business continuity planning; pay attention to legal, compliance, and liability exposures. - Scenario analysis and capital/liquidity adequacy: - Assess adequacy of banks’ climate scenario analysis and develop supervisory dialogue on results to enhance impact assessment on capital adequacy and liquidity. - Continuously improve methodologies to assess adequacy of solvency and liquidity buffers and determine whether additional Pillar 2 capital requirements and/or liquidity buffers are warranted. *Source: EXECUTIVE SUMMARY (1islea2023005) — IMF mission material provided in the content unit.* ### EXECUTIVE SUMMARY __________________________________________________________________________ 6 ### EXECUTIVE SUMMARY ### Major findings on Iceland’s climate-related financial risks and institutional context - Iceland is exposed to significant natural hazards, including volcanic eruptions and extreme weather conditions, and to physical risks from climate change such as sea acidification and melting glaciers (a long-term risk), as well as transition risks affecting sectors like fisheries and transportation. - Iceland’s abundant domestically produced renewable energies cover nearly all the country’s heat and electricity production needs. - The 2020 Climate Action Plan and the 2021 Iceland’s Strategy on Adaptation to Climate Change include ambitious objectives toward GHG emissions’ neutrality. - Coordination between the Central Bank of Iceland (CBI) and ministries/public agencies implementing climate policy is limited; the financial sector deserves greater scrutiny given its potential exposure and role as contributor to the Plan. - The CBI has a legal mandate on financial stability and financial supervision that applies to climate-related financial risks and should be involved in governmental coordination and cooperation arrangements on climate change issues. - Standard setters (BCBS, FSB, ISSB) are still developing international standards on climate-related financial risks applicable to the banking sector; EU/EBA regulations on ESG are not yet stabilized nor fully applicable in Iceland. - Icelandic banks’ exposure to climate-related financial risks cannot be precisely assessed due to significant data gaps while the regulatory framework is under construction; no global risk assessment combining quantitative and qualitative inputs has been performed so far. - Some progress has been made: enhanced Basel Pillar 3 financial disclosure on ESG in 2022; sectoral exposures (e.g., fisheries) have been highlighted in public information. - The CBI faces serious issues collecting relevant bank data needed to assess exposures to physical and transition risks. - Data quality and availability are major preconditions for effective financial supervision across banks, insurance companies, and pension funds. - The CBI should not wait for finalized EU/EBA regulations; it should enhance data availability and collect more comprehensive, granular, and risk-based data on physical and transition risks to inform supervisory action. - The CBI considers sustainable finance a strategic priority for financial supervision in 2022–24 but has not yet adopted a formal strategic roadmap or structured internal project management framework to implement effective supervision of climate-related financial risks. - By mid-March 2023, only one macroprudential specialist and one climate risk specialist were working, part-time, on climate issues within Financial Stability and Prudential Supervision, respectively, with occasional and high-level support from other supervisors. - Commendable analytical work includes a first supervisory scenario analysis on the impact of climate-related credit risk on banks’ corporate credit portfolios (March 2023). - ESG risks were considered during the 2022 supervisory review and evaluation process (SREP) of Iceland’s three larger banks, including supervisory dialogue on business model analysis and corporate governance. - The CBI is a member of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) since 2020 and closely monitors EU/EBA developments and cooperates with Nordic peers. - The intensity and thoroughness of systematic supervision of climate-related financial risks should be gradually increased, following the 18 overarching Basel Committee principles (June 2022), once data quality has been enhanced. - Supervisory tasks should combine: (1) financial stability oversight (scenario analysis and stress testing), (2) microprudential supervision (governance, risk management, credit risk, capital and liquidity impact, business model adaptation, profitability drivers), and (3) conduct supervision (quality of Pillar 3 financial disclosure). - Icelandic banks have established sustainable finance units and enhanced “green” or “blue” profiles, and have made uneven progress on Pillar 3 ESG disclosure; however, disclosure alone is insufficient—banks must upgrade risk management processes to assess exposures to physical and transition risks and the impact on prudential capital, liquidity buffers, business models, and profitability. - The CBI should support banks’ upgrades through hands-on supervisory dialogue, offsite surveillance, targeted onsite inspections, and urgent focus on ensuring reliable and relevant climate-related data production and regulatory reporting by banks. - The CBI should determine whether banks’ capital and liquidity buffers are adequate to cover climate-related financial risks and, if needed, decide additional capital and/or liquidity requirements on a case-by-case basis through informed assessment. ### Institutional recommendations and supervisory priorities - The CBI should be involved in government-level coordination on climate change and partner with stakeholders to improve production of climate-related data and to refine financial supervision strategy. - The CBI should develop a structured internal project management framework, a clear but flexible and proportionate three- to five-year action plan, and objectively estimate any need for additional staff, expertise, tools, and budget. - Supervision should proceed on a risk-based and targeted basis, leveraging existing EU/EBA requirements while tailoring implementation to Iceland’s specific needs and using the principle of proportionality. --- ### Key statistics and time markers cited in the executive summary - CBI strategic priority horizon: 2022–24. - CBI NGFS membership since 2020. - Enhanced Basel Pillar 3 financial disclosure on ESG: 2022. - First supervisory scenario analysis on climate-related credit risk: March 2023. - Staffing as of mid-March 2023: one macroprudential specialist and one climate risk specialist working part-time on climate issues. --- ### KEY RECOMMENDATIONS (extracted from Table 1) - Recommendation 1: Produce a global assessment of climate-related financial risks within the financial sector (including banks) to identify actual and potential vulnerabilities. — Responsible: CBI — Priority: MT - Recommendation 2: Clarify the expected role and contribution of the CBI and the financial sector (including banks) to implement the 2020 Iceland’s Climate Action Plan and 2021 Iceland’s Strategy on Adaptation to Climate Change at the country level. — Responsible: CBI, MoFEA, MoEEC — Priority: NT - Recommendation 3: Enhance domestic cooperation of the CBI with relevant ministries and public agencies involved in climate change issues to develop synergies supporting effective and efficient supervision of climate-related financial risks within the financial sector (including banks), while safeguarding the supervisory independence of the CBI. — Responsible: CBI, MoFEA, MoEEC, Others — Priority: NT - Recommendation 4: Tailor the implementation of the EU/EBA regulatory framework considering Iceland’s specific climate change issues to ensure adequate and proportionate supervision of climate-related financial risks in the banking sector. — Responsible: CBI, MoFEA — Priority: MT - Recommendation 5: Specify a comprehensive CBI supervisory strategy, including a structured action plan, to build an adapted supervisory framework on climate-related financial risks within the financial sector (including banks). — Responsible: CBI — Priority: NT - Recommendation 6: Assess the need for additional CBI staff, expertise, tools, and budget to ensure appropriate supervision of climate-related financial risks within the financial sector (including banks). — Responsible: CBI — Priority: I - Recommendation 7: Enhance the CBI’s internal organizational framework for oversight and supervision of climate-related financial risks within the financial sector (including banks). — Responsible: CBI — Priority: NT - Recommendation 8: Develop supervisory assessment methodology, tools, and processes considering existing and future EBA requirements for climate-related financial risks within the banking sector. — Responsible: CBI — Priority: MT - Recommendation 9: Complete the development of adapted supervisory stress testing and scenario analysis on climate-related financial risks within the banking sector. — Responsible: CBI — Priority: MT - Recommendation 10: Bridge data gaps in climate-related financial risks within the banking sector (notably, adapt the collection of useful data by relevant public agencies). — Responsible: CBI, MoECC, Others — Priority: MT - Recommendation 11: Engage the banking sector in a more proactive and thorough supervisory dialogue to strengthen respective capacities of supervisors and banks to assess and manage climate-related financial risks. — Responsible: CBI — Priority: I - Recommendation 12: Disclose supervisory expectations to banks and provide guidance on implementation of corporate governance and risk management of climate-related financial risks. — Responsible: CBI — Priority: MT - Recommendation 13: Assess the impact of climate-related financial risks on banks’ business models and profitability drivers. — Responsible: CBI — Priority: MT - Recommendation 14: Assess the adequacy of banks’ corporate governance, internal organization and resources, capacity, and internal control of climate-related financial risks. — Responsible: CBI — Priority: MT - Recommendation 15: Assess the adequacy of banks’ risk management frameworks and processes for climate-related financial risks. — Responsible: CBI — Priority: MT *Source: EXECUTIVE SUMMARY (1islea2023005) — IMF mission material provided in the content unit.* ### 16. Assess banks’ data production and reporting processes for climate-related ### 16. Assess banks’ data production and reporting processes for climate-related financial risks and enhance supervisory data collection and analysis concomitantly ### Key recommendations and supervisory priorities - Recommendation 16: Assess banks’ data production and reporting processes for climate-related financial risks and enhance supervisory data collection and analysis concomitantly. (Paras 88, 89 and 109) — Responsible: CBI — Priority: MT - Complementary recommendations within the same cluster (management, supervision, and disclosure) that relate to data, reporting, and supervisory analysis: - Recommendation 21: Determine an action plan for effective implementation of EBA data disclosure and reporting standards for climate-related financial risks applicable to the banking sector to ensure reliable data quality and relevant data accuracy. (Paras 47 to 51, and 55) — Responsible: CBI; MoFEA — Priority: NT - Recommendation 22: Develop regulatory reporting templates and key monitoring indicators of climate-related financial risks within the banking sector for supervisory purposes. (Paras 52 and 56) — Responsible: CBI — Priority: NT - Recommendation 24: Develop institutional supervisory disclosure by the CBI of relevant informative data and analysis of climate-related financial risks within the banking sector. (Paras 54 and 58) — Responsible: CBI — Priority: MT - Recommendation 23: Ensure adequate financial disclosure of climate-related financial risks by banks. (Paras 52 and 57) — Responsible: CBI — Priority: MT ### Rationale and context from the FSAP technical note - General drivers for the recommendation: - Progress in risk management and supervision of climate-related financial risks has been hampered by data gaps, resource constraints, lack of harmonized methodologies and risk metrics, and lack of broadly agreed international standards on climate-related financial risks. (Intro, Para 2) - The IMF FSAP mission found a lack of official data on climate-related financial risks; accordingly, data analysis on banks’ exposure was limited and the technical note mentions only public information. (Para 6) - No public climate-related information specific to the financial sector (risk assessment of exposure to physical and transition risks) was identified from official sources, including ministries and the CBI. (Para 14) - International and regional standard-setting context: - The Basel Committee on Banking Supervision (BCBS) issued “Principles for the effective management and supervision of climate-related financial risks” (June 2022), which provides overarching guidance. (Para 3) - The European Banking Authority (EBA) is still working on standards and guidelines incorporating climate-related financial risks; implementation is being finalized or enforced progressively beyond 2023. Iceland, as an EEA country, will benefit from the EU/EBA framework when building its national framework. (Para 4) - Implementation constraints noted by the mission: - The global risk assessment of climate change at the country level is a complex project not yet fully completed; information is not centralized and numerous sources from various ministries and public agencies must be combined to capture the country’s risk assessment. (Para 13) - Given the lack of centralized and official data, the FSAP mission’s assessment of banks’ exposure was limited and relied on public information and insights shared by authorities and experts. (Para 6) ### Operational elements that supervisory assessment should cover - Evaluate banks’ internal data production processes for climate-related metrics, including: - Data sources used (internal systems, external providers, satellite/physical hazard data). - Data governance arrangements for climate data (quality controls, ownership, documentation). - Frequency and granularity of data collection relevant to physical and transition risks. - Assess banks’ reporting processes and the readiness to meet prospective disclosure and supervisory reporting standards: - Alignment with EBA data disclosure and reporting expectations and evolving EU/EBA standards. (Recommendation 21) - Existence and use of regulatory reporting templates and key monitoring indicators for climate-related financial risks. (Recommendation 22) - Financial statement disclosure and supplementary reporting practices for climate-related exposures and scenario analysis results. (Recommendation 23) - Enhance supervisory collection and analytical capacity: - Develop supervisory templates and key monitoring indicators to collect consistent, comparable data across banks. (Recommendation 22) - Build CBI institutional supervisory disclosure capacity to publish informative data and analysis on climate-related financial risks. (Recommendation 24) - Integrate data collection with supervisory impact assessment of capital adequacy and liquidity (see related Recommendation 20 on scenario analysis). (Paras 99 and 113) ### Links to related supervisory priorities in the FSAP - Data and reporting improvements are a foundational step to evaluate: - Climate-related credit risk exposures and adequacy of adjusted credit risk management and mitigation techniques. (Recommendation 17 — Paras 92 and 110) — Responsible: CBI — Priority: MT - Climate-related market, liquidity, and funding risks to evaluate banks’ exposure to climate-related liquidity risk. (Recommendation 18 — Paras 94, 96 and 111) — Responsible: CBI — Priority: MT - Incorporation of climate-related drivers into operational risk management processes beyond business continuity planning. (Recommendation 19 — Paras 98 and 112) — Responsible: CBI — Priority: MT - Adequacy of banks’ climate scenario analysis and supervisory dialogue on results to enhance impact assessment on capital adequacy and liquidity. (Recommendation 20 — Paras 99 and 113) — Responsible: CBI — Priority: MT ### Expected outcomes from implementing the recommendation - Improved data quality and comparability across banks to enable: - More robust supervisory assessment of banks’ exposure to physical and transition risks. - Enhanced ability to perform supervisory stress testing and scenario analysis to assess capital and liquidity impacts. - More consistent and reliable public disclosure by banks and institutional supervisory disclosure by the CBI. - Progress toward aligning national supervisory practice with international guidance (BCBS principles) and evolving EU/EBA disclosure and reporting standards. *Source: IMF FSAP Technical Note (Iceland), chapter on Assess banks’ data production and reporting processes for climate-related financial risks (Paras and recommendations as listed in source).* ### Appendix I provides a tentative list of reference documents identified by IMF staff from public sources of ### 1islea2023005 - Appendix I provides a tentative list of reference documents identified by IMF staff from public sources of ### Coordination and institutional integration - The Central Bank of Iceland (CBI) is not yet fully integrated into the authorities’ strategic coordination framework on the response to climate change despite a formal interministerial committee and informal networking. - Closer cooperation involving the CBI is recommended because: - The financial sector (banks, insurance companies, pension funds, securities markets) should support the economy in reaching adaptation objectives. - Financial regulation and supervision should consider climate-related strategic risks, for example in business model analysis via the annual supervisory review and evaluation process (SREP) of larger banks. - The CBI may share scenario analysis and risk assessment of climate-related financial risks with ministries and public agencies to produce relevant data and avoid overburdening financial institutions with nonrelevant or immaterial data. - Government agencies can provide data beyond banks’ usual scope (for instance, on energy efficiency of properties) needed to comply with EU/EBA regulations. ### National strategies, plans, and public financial management - Iceland’s 2020 Climate Action Plan (an update of the 2018–30 Plan) expects a minimum of ISK 46 billion to be spent on key climate actions during 2020–24; the plan comprises 48 actions and has been shared in a summary document in English. - As of March 2023, no implementation update of the 2020 plan had been disclosed. - The national adaptation strategy was defined in 2021, but the national adaptation plan is still under preparation; the MoEEC states “a country wide adaptation plan is under way, and the research on which to build such a plan is ongoing”. - The 2021 Strategy on Adaptation to Climate Change includes eight specific goals relating to insurance and financial activities (Section J, J1–J8), which recognize the financial sector’s contribution but do not place financial stability as the clear underlying concern. - The MoFEA published a Sovereign Sustainable Financing Framework to promote “green financing” and “blue financing”; the Framework aims to align with: - Green Bond Principles (2021) - Green Loan Principles (2021) - Social Bond Principles (2021) - Sustainability Bond Guidelines (2021) - Climate Bonds Standard (2019) - The Sovereign Sustainable Financing Framework has been benchmarked, to the extent possible, to the EU Taxonomy for sustainable economic activities and a draft of the European Green Bond Standard; Government Debt Management can issue green, social, blue, and/or sustainable instruments. ### Central Bank of Iceland — strategy, mandate, and internal capacity - The CBI included sustainable finance as one of four major objectives in its 2022–24 supervisory strategy. - The CBI issued a sustainability report in July 2022 and made an individual pledge for COP26 (November 2021). - The CBI’s Financial Stability Committee received a presentation on climate-related financial risks in December 2022; the Financial Stability Council has not yet discussed them. - The CBI released the Financial Stability Report (FSR) on March 15, 2023, which includes an informative box on the impact of climate risk on Icelandic banks’ credit risk and selected results from a first scenario analysis performed in 2022. - The last annual report on Financial Supervision (disclosed in March 2023) did not mention sustainable finance as a key priority objective for 2023, implying an implicit downgrade of visibility for the CBI’s medium-term supervisory commitment on climate-related financial risk. - The CBI’s existing legal mandate covers financial stability, prudential supervision, and conduct supervision across banks, insurance companies, pension funds, and securities markets, enabling it to supervise climate-related financial risks, provided supervisory priorities remain balanced to preserve the CBI’s main mandates. ### Supervisory implementation and processes - Implementation strategy and action plans specific to climate-related financial risks within the banking sector remain to be developed further by the CBI, taking into account upcoming international standards and EU/EBA regulations applicable to Iceland. - Since January 2023, climate change has been incorporated into the work scope of the Financial Stability, Prudential Supervision, and Conduct Supervision departments. - Preparatory work on implementing EBA standards and guidelines is underway; a first scenario analysis has been performed by the Financial Stability Department. - The Prudential Supervision Department implemented several supervisory tasks related to climate change during the annual SREP of larger banks in 2022. - Internal supervisory procedures and processes have not yet fully incorporated all tasks on climate-related financial risks; transitional simplified procedures focusing on core supervisory tasks may be useful before EBA standards are finalized. ### Resources, staffing, and organisational challenges - The internal organizational framework on climate-related financial risks is being structured progressively, but limited human resources are a major constraint. - Illustration of staffing: - Two specialists in prudential supervision and financial stability work part-time on climate issues, with some support from other specialists and supervisors. - By end-March 2023, the CBI hired a new climate expert working full-time on climate-related financial issues. - The FSAP mission did not receive documentation on internal action plans for banking supervision specifying roles and responsibilities, objectives, human resources/staffing, and budget. - The CBI’s reform management for building the supervisory framework on climate-related financial risks appears informal and would benefit from better structuration, dedicated internal infrastructure, and project management techniques. - The FSAP assessment finds the supervisory response to climate-related financial risks needs significant development with additional resources to reach effective and adequate banking supervision objectives over a reasonable medium-term horizon. ### Banks, disclosure, and market initiatives - The Icelandic banking sector is concentrated with three banks classified as domestic systemically important banks (D-SIBs) and representing most of the banking sector. - Larger banks are developing risk management and disclosure of climate-related financial risks through: - ESG reports - Enhanced Basel Pillar 3 disclosure reports (including ESG risks) - ESG ratings by external rating agencies - These initiatives are commendable but uneven across banks; accuracy of disclosure and adequacy of risk management remain to be assessed by the CBI via supervisory processes. - Banking institutions participate in various international and domestic cooperation initiatives on sustainability, as noted in larger banks’ 2022 sustainability disclosures. ### International cooperation and regulatory alignment - The CBI has been a member of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) since 2020. - The CBI participates in supervisory cooperation agreements with other Nordic countries; a senior climate risk expert returned to the CBI in 2022 after a secondment at the EBA. - As an EEA member, Iceland incorporates and transposes EU legislation relevant under the EEA agreement; Icelandic banking law (Act No. 161/2002 on Financial Undertakings) is almost entirely based on European regulation. - EU regulations and EBA standards/guidance are not tailored to Iceland’s specifics; the authorities should apply the principle of proportionality when determining implementation strategies of EU/EBA regulations. - Given limited cross-border banking activities, coordination with foreign supervisory authorities has not been a priority; existing bilateral MoUs have not been widely used. *Source: IMF staff compilation from Appendix I and sections C–E of the IMF FSAP chapter on Iceland (material excerpted from the provided PDF).* ### 32. Produce a global assessment of climate-related financial risks within the financial ### 32. Produce a global assessment of climate-related financial risks within the financial sector to identify actual and potential vulnerabilities. ### Strategic recommendations for Icelandic authorities and the CBI - Produce a global assessment of climate-related financial risks within the whole financial sector (including the banking sector, insurance companies, and pension funds) to identify actual and potential vulnerabilities. - Clarify the expected role and contribution of the CBI and the financial sector to implement the 2020 Iceland’s Climate Action Plan and 2021 Iceland’s Strategy on Adaptation to Climate Change at the country level; better reflect the role of the financial sector (banking, insurance, pension funds) in the governmental strategic roadmap. - Enhance domestic cooperation of the CBI with relevant ministries and public agencies (for instance, the MoEEC, or the Icelandic Climate Council) to develop synergies supporting effective and efficient supervision of climate-related financial risks within the financial sector (including banks). Aim to coordinate on data classification, production, and disclosure. - Tailor the implementation of the EU/EBA regulatory framework considering Iceland’s specific climate change issues to ensure adequate and proportionate supervision of climate-related financial risks within the banking sector. Supervisory guidance for banks should explicitly state supervisory expectations. - Specify a comprehensive CBI supervisory strategy with a structured action plan and a global roadmap on supervision of climate-related financial risks (at least within the banking sector) including: - relevant strategic objectives, - action plans, - expected outcomes, - responsibilities, - resources. - Assess the need for additional CBI staff, expertise, tools, and budget to ensure appropriate supervision across banks, insurance companies, and pension funds; include macroprudential oversight, offsite supervision, onsite inspection, and other duties. - Make a forward-looking estimate of additional staffing, expertise, and funding needs targeting a fully operational supervisory framework on climate-related financial risks within the next three to five years. Request an additional multiyear budget from the appropriate authorities to meet these needs. ### Overview of the banking sector’s exposure to climate-related financial risks (limited quantitative illustration) - The chapter provides a limited quantitative illustration; it does not make a risk assessment of the banking sector nor measure banks’ vulnerabilities to climate-related financial risks. - Data collection on climate-related financial risks is ongoing and challenging due to: - lack of enforceable international standards for banks on financial disclosure of climate-related financial risks; - ongoing standard-setting at European and euro area levels, prompting Icelandic authorities to wait before enforcing a national disclosure framework; - lack of public information and data on climate-related financial risks in Iceland at the time of the mission. - The development of a structured taxonomy and data reporting framework will consider the EU Taxonomy Regulation (to be transposed by the Icelandic Parliament in 2023) and future EBA guidelines expected in 2023. - Disclosure by regulated financial institutions and the CBI of data on climate-related financial risks was informative in 2022 but could be enhanced. ### Key illustrative data points and findings from available sources - Commercial banks’ corporate credit portfolios (only loans above ISK 300 million) were composed of: - 75 percent of “green” loans, - 16 percent of “neutral” loans, - 9 percent of “brown” loans, (in terms of GHG emissions’ footprint) — breakdown derived from the Credit Registry/Central Bank of Iceland database (March 2023 Financial Stability Report). - The CBI has not assessed the quality and reliability of data reported by banks to the Credit Registry on classification of loans to various corporate sectors, nor green loans. - Banks lack granular data for measuring the GHG emissions’ efficiency of immovable real estate collateral, which is an EU requirement for climate-related classification of exposure. - Example bank disclosures and illustrations (not directly comparable across institutions): - Arion Banki reported a ratio of carbon-related assets to the total loan book of 37 percent (year-end 2022). - Arion Banki disclosed financed CO2 emissions due to the loan book in 2021 (reported in ktCO2e). - Islandsbanki disclosed emissions from balance-sheet activities in 2021 and sustainable assets at year-end 2020–22. - Landsbankinn disclosed GHG emissions from the loan portfolio by year-end 2022. - Icelandic banks may be relatively less exposed than other countries to credit risks resulting from climate-related transition risks, given the country’s risk profile and ambitious Climate Action Plan; however, no reliable standardized data are available to quantify banks’ exposure to transition risks. ### CBI scenario analysis and dashboard outputs - The Central Bank of Iceland produced a first scenario analysis; outcome released on March 15, 2023, during the FSAP mission. The Financial Stability Department conducted the analysis, focused on the impact of climate change on credit risks covering banks’ corporate loan portfolios. - Data used by the CBI for the simulation were mostly from the Credit Registry; the mission did not receive the underlying data but the CBI shared several dashboards from the Financial Stability Department. - CBI dashboard highlights (as disclosed in the Financial Stability Report 2023/1): - sectoral emissions are concentrated, - loan carbon intensity has been estimated, - sectoral share of brown corporate loans is high in fisheries, - sectoral share of neutral corporate loans is high in manufacture of food products, - green loans account for 75 percent of total corporate loans, - results of three climate scenarios were evaluated. ### Supervisory reporting and financial disclosure framework (high-level overview) - Implementing a disclosure framework is important for developing sound risk management and effective banking supervision; typology and taxonomy of climate-related financial risks remain under discussion internationally and in the EU. - The Basel Committee supports development of a Pillar 3 disclosure framework on climate-related financial risks, which should build on and complement disclosure initiatives by the International Sustainability Standards Board (ISSB). The FSB’s Task Force on Climate-Related Financial Risk (TFCR) will develop a set of bank-specific Pillar 3 disclosure requirements. - As an EEA member, Iceland implements EU and EBA norms on ESG risks that incorporate climate-related financial risks. Iceland incorporates relevant EU/EBA rules and guidance into Icelandic law without tailoring these norms specifically to Iceland. - Effective implementation of EU guidelines and regulations specific to taxonomy and disclosure of ESG risks was at an early stage as of March 2023; legal adoption of the EU taxonomy regulation was underway with implementation expected by mid-2023. - The EBA has developed implementation standards and guidelines for ESG risks and has upgraded the SREP to include ESG risks. Recent developments include: - 2021 EBA Report on management and supervision of ESG risks for credit institutions and investment firms; - 2022 Implementing Technical Standards (ITS) on prudential disclosures on ESG risks. - The CBI considered the revised EBA SREP guidelines when implementing the 2022 SREP of larger Icelandic banks, incorporating ESG risks into governance and business model analysis. *Source: Excerpt from the provided IMF material.* ### 50. Regulatory requirements for banks’ financial disclosure have been enhanced since 2022 ### 50. Regulatory requirements for banks’ financial disclosure have been enhanced since 2022 ### Pillar 3 report and EBA/EU disclosure framework - The annual Pillar 3 report that banks are expected to publish should comply with EU Regulation 2021/637 (amended in 2022 to include ESG risks) on disclosure requirements under Part Eight of the Capital Requirements Regulation (CRR). - The new Pillar 3 report should present information and data in accordance with the disclosure requirements in the form of standardized tables and templates. - The Pillar 3 report is intended to allow market participants to assess key information on capital, risk exposures, risk assessment processes, and hence capital adequacy, incorporating an ESG perspective. - The EBA asks banks to disclose: - Climate risks: how climate change may exacerbate other risks within banks’ balance sheets (examples given: stranded carbon intensive assets; loans to property within a flood plain). - Mitigating actions: what mitigating actions banks have in place to address those risks, including financing activities that reduce carbon emissions. - Green Asset Ratio (GAR) and Banking Book Taxonomy Alignment Ratio (BTAR): to understand how institutions are financing activities aligned with the Paris Agreement objectives based on the EU taxonomy of green activities. - ESG strategies, governance, and risk management arrangements with regard to ESG risks. - The EBA will ask banks to disclose exposures to carbon-intensive activities and assets that may experience physical risks as a result of climate change, broken down to include: - Information toward fossil fuel companies excluded from sustainable climate benchmarks. - Information toward other carbon-related sectors, as identified in the same sustainable climate benchmark regulation. - Information on GHG emissions financed by the institution and on alignment of metrics with 2050 Net Zero goals. - These disclosures are aligned with FSB’s TCFD recommendations but use a broader definition of carbon-related sectors. ### Data sources, KPIs, and timelines specified by the EBA - The EBA designed KPIs on taxonomy alignment disclosure requirements to match data and timelines that large corporates under the Non-Financial Reporting Directive (NFRD) are required to produce, according to Article 8 of the Taxonomy Regulation. - The EBA set out guidance that banks should capture ESG information in EBA Guidelines on Loan Origination and Monitoring. - Information necessary for the calculation of the BTAR shall be obtained on a best-effort basis in the context of bilateral relationships or, when needed, using estimates, without creating disclosure obligations to counterparties. - The EBA expects reliable data for the GAR from December 2023 for counterparties subject to NFRD disclosure obligations and households, and on the BTAR for June 2024. ### Icelandic implementation and supervisory status (CBI) - The CBI has not yet assessed banks’ 2022 Pillar 3 reports, but assessments are planned to be one of the first concrete supervisory tasks to implement from a microprudential supervision perspective. - Given ongoing development of international standards and upcoming applicability of EU/EBA rules, the annual Pillar 3 reports are not supplemented by additional specific Icelandic legislation. - The Annual Accounts Act recently requires pension funds, credit institutions, and insurance firms to include a discussion of environmental, social, and human resources in their annual reports, publish a summary of policy results, and describe key risks and responses. - The authorities are waiting for release of final standards and rules before incorporating them into national legislation with corresponding binding status. - No tailoring of EBA disclosure requirements has been planned for Iceland, and no impact study has been conducted by banking supervisors. - Larger banks have started to implement Pillar 3 ESG disclosure requirements by publishing ESG reports in 2022, but CBI supervisors have not yet assessed alignment with EBA expectations. - At the time of the FSAP mission, it was too early to produce any relevant global assessment of the adequacy of financial disclosure of climate-related financial risks by banks. ### Supervisory reporting on climate-related financial risks (CBI gaps) - The Central Bank of Iceland (CBI) has not issued any specific regulatory reporting requirements for climate-related financial risks. - The CBI has not determined whether additional reporting requirements would be useful at the national level, nor whether to tailor banking supervision and macroprudential oversight to Icelandic specificities. - The CBI has not issued regulatory templates for periodic standardized reporting or ad hoc reporting to banking supervisors for macroprudential oversight and microprudential supervision pertaining to climate-related financial risks. - The use of key indicators for climate-related financial risks within the Icelandic banking sector is not yet part of supervisory processes. - At the time of the FSAP mission, CBI supervisors had not adopted an implementation policy nor issued guidance to banks for calculation of KRIs/KPIs such as the GAR, which will come into force by end-2023. Preparations should take place during 2023 to meet the EBA deadline. ### CBI public disclosure and supervisory communications - The CBI has published official statements of commitment, the 2021 sustainability report, the 2022–24 supervisory strategy for the financial sector (2022) including a strategic objective on sustainable finance, and a box on climate-related credit risk in the 2023/1 Financial Stability Report. - Public information including quantitative data and qualitative analysis on banks’ risk exposure and management is limited (only a few tables and charts are in the FSR). - The CBI has not yet specified short-term supervisory objectives on climate-related financial risks within the banking sector. ### Key findings on supervisory capacity and preparedness - The CBI has an adequate legal mandate to oversee and supervise climate-related financial risks in the banking sector (Acts cited: Act No. 161/2002 on Financial Undertakings; Act No. 87/1998 on Official Supervision of Financial Activities). - The CBI’s strategic planning for implementing banking supervision of climate-related financial risks is barely structured; preliminary technical work has started but no formal strategic action plan has been designed or endorsed by the Financial Supervision Committee or the Financial Stability Committee. - Organizational adaptations have been made: creation of the Prudential Supervision Department and the Conduct Supervision Department (microprudential), and the Financial Stability Department (macroprudential). Oversight and supervision of climate-related financial risks are handled within these three Departments. - Interdepartmental cooperation remains informal; a new climate expert was appointed at the Governor’s Office by late March 2023. - By mid-March 2023, there were only two CBI specialists with relevant expertise in climate-related financial risks; a new employee with climate expertise but no supervisory experience was hired during the mission. A sustainable officer would also be hired in the Conduct Supervision Department. - The CBI has not estimated anticipated additional supervisory resources and capacity needs for the next three to five years, nor multiyear budget needs for staffing, tools, and outreach. - Development of supervisory processes is preliminary. The CBI has engaged with banks through: - The supervisory review and evaluation process (SREP) implemented in 2022 for the three larger banks. - A first climate scenario analysis in 2022–23 (outcome published as an article in the March 2023 Financial Stability Report). - Internal supervisory procedures and processes will need adjustment once the regulatory framework stabilizes and is enforced. Collection of additional information and data from banks has barely started. ### Recommendations (CBI and authorities) - Determine an action plan for effective implementation of EBA data disclosure and reporting standards for climate-related financial risks applicable to the banking sector to ensure reliable data quality and relevant data accuracy. - In liaison with relevant governmental authorities and the banking sector, clarify and specify internal and external objectives for timely implementation of EU regulations and EBA standards and guidelines. - Approve a dedicated roadmap including concrete objectives, actions, outcome indicators, resources, and deadlines. - Consider the principle of proportionality when implementing EU/EBA requirements. - Develop regulatory reporting templates and key monitoring indicators (KRIs/KPIs) of climate-related financial risks within the banking sector for supervisory purposes. - Reporting templates and KRIs/KPIs should be developed, enforced, and used. - Regulatory disclosure should be aligned with future EBA requirements and possibly finetuned for Iceland-specific climate-related risk environment. - Ensure adequate financial disclosure of climate-related financial risks by banks. - Banks’ financial disclosure should include more granular data and information on exposure to, risk management of, and mitigation of climate-related financial risks, including physical and transition risks. - Enhance financial disclosure by insurance companies and pension funds as well, considering proportionality. - Develop institutional supervisory disclosure by the CBI of informative data and analysis on climate-related financial risks within the banking sector. - Prioritize banking sector data disclosure, and include insurance sector and pension funds as relevant. - When preparation steps are advanced enough, the CBI should publish periodic information on banks’ risk exposure, risk assessment, risk management, risk mitigation, and other relevant topics, including: 1. Aggregated data, as well as KRIs/KPIs; 2. Supervisory stress test results; and 3. Supervisory analysis and risk assessment. - Such disclosure would contribute to transparency of the banking sector’s risk profile, management, and mitigation. *Source: IMF staff summary of "50. Regulatory requirements for banks’ financial disclosure have been enhanced since 2022" (text as provided).* ### 66. Supervisory expectations on management of climate-related financial risks have yet to ### 66. Supervisory expectations on management of climate-related financial risks have yet to ### Supervisory expectations, disclosure, and communication - By March 2023, the CBI had not yet disclosed supervisory expectations for effective, adequate, and proportionate implementation of standards for risk management and disclosure of climate-related financial risks, tailored to the Icelandic banking sector at the national level. - Disclosure is considered likely premature at the preliminary stage of the reform because: - EU regulations on ESG disclosure have been issued and will become applicable in coming years. - The EBA’s issuance of standards and guidelines is ongoing, but they are not yet fully enforceable within the EU nor in Iceland. - Banks are aware of publications and public drafts pertaining to the European regulatory framework. - Institutional communication by the CBI on supervisory expectations and preparatory steps has not started: - No publication has been produced. - No outreach communication event has been held to raise the banking sector’s awareness of climate-related financial risks. ### Supervisory tools, techniques, and scenario analysis - The CBI is at a preliminary stage of creating supervisory procedures and processes, and designing IT tools, techniques, databases, and assessment methodology for oversight and supervision of climate-related financial risks. - Progress is acknowledged as necessary but not planned in a systematic way; a dedicated action plan with priority ranking to incorporate climate-related work into supervisory processes would be useful. - Principle 18 (excerpt): Supervisors should consider using climate-related risk scenario analysis to identify relevant risk factors, size portfolio exposures, identify data gaps and inform the adequacy of risk management approaches. Supervisors may also consider climate-related stress testing and, where appropriate, disclosing findings. - The CBI implemented the first climate scenario analysis; outcome disclosed in the March 2023 CBI Financial Stability Report. - The published analysis is a top-down analysis of climate-related financial risks (especially transition risks) on banks’ credit portfolios—focused on corporate loans. - The CBI mostly used available data from the Credit Registry, not data directly collected from banks. - The CBI plans to expand to other risk types and to conduct a bottom-up exercise in cooperation with banks. - The CBI used the ESRB/ECB scenario analysis published in July 2022 as a role model. - NGFS scenarios provide downscaled information including economic variables from the NiGEM macroeconomic model; NiGEM does not yet apply to Iceland, but the Department of Economic Affairs is working on implementing the NiGEM model. - The CBI plans to explore available data (e.g., internal economic model QMM) and perhaps buy rights to access additional data sources to implement NGFS scenarios fully. - The CBI plans to leverage its climate scenario analysis to develop solvency and liquidity stress testing further and to better define supervisory objectives. - Climate-related stress testing is not yet used to assess adequacy of banks’ solvency and liquidity buffers for climate-related financial risks. - The CBI’s climate stress tests and standard stress tests are currently separate exercises. - The EBA is considering taking ESG risks, including climate-related financial risks, in its next review of SREP guidelines; such risks have not been included in the Basel Pillar 2 requirement process in Iceland yet. - The CBI intends by end-2023 to enforce a new law on the disclosure of sustainability and taxonomy for sustainable finance (planned to be adopted by the Parliament in mid-2023). - Supervisory scenario analysis is too preliminary to identify data gaps and size portfolio exposure. - The CBI needs to prioritize bridging data gaps internally and in collaboration with banks and public agencies (for instance, Statistics Iceland). - The CBI has not yet taken initiatives to bridge these data gaps. ### Prudential regulatory and supervisory requirements (SREP, ICAAP/ILAAP) - Principle 13 (excerpt): Supervisors should determine that banks’ incorporation of material climate-related financial risks into business strategies, corporate governance, and internal control frameworks is sound and comprehensive. - Principle 14 (excerpt): Supervisors should determine that banks can adequately identify, monitor, and manage all material climate-related financial risks as part of their risk appetite and risk management frameworks. - Principle 15 (excerpt): Supervisors should determine the extent to which banks regularly identify and assess the impact of climate-related risk drivers on their risk profile and ensure these risks are considered in credit, market, liquidity, operational, and other types of risk; supervisors should determine that, where appropriate, banks apply climate scenario analysis. - Supervisory assessment of corporate governance on climate-related financial risks: - A first round of discussions on governance of ESG risks and climate-related issues occurred during the 2022 SREP of larger banks. - The CBI has not yet reviewed nor thoroughly assessed whether banks have fully integrated climate-related risk drivers into business strategies, corporate governance, and internal control frameworks. - Roles and responsibilities of boards and senior management, and internal reporting on climate-related financial risks, remain to be assessed. - Banks’ 2022 Pillar 3 reports indicate larger banks have set up sustainability committees and included ESG risks in governance frameworks, but high-level public information needs more granular assessment. - Supervisory assessment of banks’ risk management strategies and objectives for climate-related financial risks has not been systematic: - The CBI has not reviewed the extent to which banks regularly assess materiality of climate-related financial risks supported by appropriate KRIs and risk-mitigating measures. - The CBI needs to assess incorporation of climate-related financial risks into risk strategy, risk appetite (including risk exposure limits), and risk management frameworks. - Larger banks’ 2022 Pillar 3 reports show policies and strategies on ESG risks with varying levels of detail; adequacy and implementation have not been formally examined. - Supervisory assessment has not yet covered inclusion of climate-related risk drivers in banks’ risk assessment and risk management policies: - The CBI has not structured a supervisory process nor engaged in supervisory action to ensure banks: (1) consider a range of mitigation options to manage material climate-related risks; and (2) consider climate-related financial risks assessed as material over relevant horizons within ICAAP and ILAAP. - Some specific requirements exist (e.g., EBA guidelines for loan origination and monitoring, Article 208, requiring consideration of ESG factors when valuing immovable property collateral), but coverage is limited. - The CBI plans to conduct supervisory assessments of banks’ scenario analysis policies and processes after EBA guidelines on institutions’ stress testing have been reviewed, tentatively by 2023, and implemented within Icelandic legislation. - To date, the CBI has not determined whether banks effectively implement adapted scenario analysis for resilience of business models and strategies. - The CBI did not leverage banks’ scenario analysis experience to inform its first supervisory scenario analysis (published March 2023) due to time constraints. - More thorough dialogue, guidance, and information sharing with banks would be useful. ### Management of climate-related financial risks: corporate governance and controls - Principle 1 (excerpt): Banks should implement a sound process for understanding and assessing impacts of climate-related risk drivers over various horizons and incorporate them into business strategies and risk management. - The CBI has implemented EU regulations and EBA guidelines on corporate governance that include ESG requirements: - EBA/GL/2021/05 on internal governance requires boards to take into account ESG risks (including material physical and transition risks) when developing business strategies. - EBA guidance on remuneration states remuneration policies should be in line with ESG strategies; existing legal requirements already link remuneration to overall strategies, objectives, values, risk appetites, and long-term interests. - During the 2022 SREP, the CBI noted climate-related factors should be more visible in remuneration policies; no formal supervisory action was decided. - Banks’ disclosures and initiatives: - Financial disclosure of 2022 annual accounts by the three larger banks reveal awareness of ESG-related objectives, risk management, and disclosure; progress is uneven. - Reitun (national ESG rating agency) evaluated banks’ ESG frameworks and gave good ratings; however: - Not all Reitun evaluations occurred after the latest international standards and EU/EBA guidelines. - Reitun’s methodology refers mostly to global guidance (United Nations, Nasdaq) that is less focused than BCBS principles on climate-related financial risks for banks. - The CBI indicated Reitun is not a regulated external rating agency and Reitun’s methodology has not been evaluated from a risk-based and prudential viewpoint. - Supervisory assessment of impact on banks’ business models: - The 2022 SREP assessed three larger banks’ business plans, which were designed before finalization of the 2021 EBA governance guidelines and the 2022 BCBS principles on climate-related financial risks. - One bank was advised to start integrating ESG more effectively into strategy and business planning. - The CBI plans deeper discussions in 2023; it is premature to evaluate how physical and transition risks would impact resilience of banks’ business models. - Several banks have included environmental risk factors in stress test scenarios for ICAAP/ILAAP and recovery plan scenario analysis, but practices are neither systematic nor thorough. - Principle 2 (excerpt): Boards and senior management should assign climate-related responsibilities and exercise oversight; identify responsibilities across the organization. - Boards are increasingly considering climate-related financial risks; EBA/GL/2021/06 on suitability requires effective oversight and management of all risk domains, including ESG. - Annual self-assessments during 2022 SREP reflected increased focus on ESG; more concrete illustrations of board and senior management involvement are needed to demonstrate effective focus on climate-related financial risks. - Banks’ operational initiatives (examples, not comprehensive): - Setting up a sustainability committee. - Adopting an environmental and climate policy. - Developing green finance products. - Deciding sustainability objectives for 2023 to reach GHG and net-zero strategic objectives. - Reporting on financed GHG emissions; disclosing the bank’s GHG emissions footprint and ratio of carbon-related assets in the total loan book using the TCFD definition. - Participating in domestic and international cooperation initiatives. - Carrying out an ESG risk assessment for corporate customers. - Capacity building: - Larger banks have adopted sustainability policies approved by the board, set up sustainability committees, created dedicated units, and hired staff with ESG expertise. - The adequacy of banks’ human resources and expertise has not been assessed by the CBI; the CBI plans to do so during the 2023 SREP on larger banks. - FSAP meetings with banks’ representatives indicated banks take climate-related financial risks seriously, presenting a strategic opportunity for intensified supervisory dialogue. ### Internal control frameworks - Principle 3 (excerpt): Banks should adopt appropriate policies, procedures, and controls across the organization to manage climate-related financial risks. - Effective adoption and implementation through operational processes (for example, credit risk management) needs to be assessed; no information currently illustrates concrete incorporation into operational processes. - The CBI has not yet performed in-depth assessment through offsite supervision or on-site inspections. - Principle 4 (excerpt): Banks should incorporate climate-related financial risks into internal control frameworks across the three lines of defense, including internal audit. - Limited supervisory evidence that banks have effectively included climate-related financial risks in internal control frameworks and internal audit. - EBA/GL/2021/05 on internal governance implies internal control frameworks should cover all risk domains, including climate-related financial risks. - The CBI discussed coverage with internal audit and risk management during the last SREP, but effective coverage by the “three lines of defense” remains to be assessed. - The CBI would benefit from periodic inputs from banks’ risk management and internal audit (e.g., risk dashboards, audit reports) to better understand implementation of adequate and independent internal control. ### Capital and liquidity adequacy - Principle 5 (excerpt): Banks should identify and quantify climate-related financial risks and incorporate those assessed as material over relevant horizons into ICAAP and ILAAP, including stress testing programs where appropriate. - The chapter ends outlining Principle 5 and the expectation for banks to incorporate material climate-related financial risks into internal capital and liquidity adequacy processes; supervisory assessment and implementation details remain to be completed. *International Monetary Fund — Iceland Financial Sector Assessment (excerpt).* ### 83. The impact assessment process of climate-related financial risks on banks’ solvency has ### 1islea2023005 - 83. The impact assessment process of climate-related financial risks on banks’ solvency has ### Impact on banks’ solvency and ICAAP (paragraphs 83–85) - 83: The impact assessment process of climate-related financial risks on banks’ solvency has not yet matured. - 83: The CBI indicated that banks are not yet explicitly required to include climate-related financial risks in their ICAAP, in view of assessing the impact of such risks on their capital adequacy. - 83: Banks have started to incorporate solvency impact assessment of climate-related financial risks into their internal stress testing and ICAAP processes. Current bank practice is to include climate-related financial risks in ICAAP reports without trying to quantify their impact on capital. - 83: Therefore, the materiality of potential needs of additional capital resulting from climate-related financial risks has not been assessed over near- to long-term horizons yet. - 84: The impact assessment of climate-related financial risks on banks’ liquidity has not been developed so far. - 84: The CBI indicated that banks are not yet explicitly required to include climate-related financial risks in their ILAAP, in view of assessing the impact of such risks on their liquidity adequacy and funding. - 84: The CBI cannot assess whether climate-related financial risks could cause net cash outflows or depletion of liquidity buffers, assuming either business-as-usual conditions or external shocks (considering severe yet plausible stress scenarios). ### Development of banks’ risk analysis, stress testing, and supervisory adaptation (paragraphs 85–89, 99) - 85: Banks’ risk analysis and stress testing capabilities regarding climate-related financial risks are being developed. - 85: EBA Report EBA/REP/2021/18 on management and supervision of ESG risks has not been legally enforced in Icelandic legislation yet. - 85: Regulation and supervisory processes have not yet been structured to advise banks to: - build risk analysis capabilities by identifying relevant climate-related risk drivers that may materially impair their financial condition; - develop KRIs and metrics to quantify exposure to these risks; and - assess the links between climate-related financial risks and traditional financial risk domains (credit risks, liquidity and funding risks). - 85: Icelandic banks have started to incorporate climate-related financial risks into climate change-related scenarios used for internal stress testing; one bank is considering a scenario focusing on the fishing industry. - 88–89: Banks’ data collection and aggregation processes on climate-related financial risks for internal risk management have not been assessed; no specific requirements have been issued on data production and management infrastructure. - 89: Supervisory data collection and analysis of climate-related financial risks within the banking sector are in a preliminary stage; lack of data is one of the largest hindrances. - 99: Internal scenario analysis on climate is not yet a requirement, but banks have been taking first steps; supervisors plan to consider them in the next round of SREP for larger banks. - 99: The CBI plans to conduct a bottom-up climate scenario analysis in cooperation with the banks in the near future. ### Risk management frameworks and supervisory assessment (paragraphs 86–87, 97–98) - 86: Banks’ risk management frameworks and processes relating to climate-related financial risks have not yet undergone supervisory assessment. - 86: Specific legal requirements on risk management of climate-related financial risks are not yet in place; EBA is developing ESG risk management guidelines. - 86: Banks are not yet required to regularly carry out a comprehensive assessment of climate-related financial risks, set clear definitions and thresholds for materiality, nor to develop appropriate KRIs aligned with monitoring and escalation arrangements. - 86–87: The CBI has not started to assess the adequacy of banks’ risk management frameworks and processes relating to climate-related financial risks; available information on banks’ existing frameworks is limited. - 97: Specific supervisory requirements or guidance on climate-related operational risk are not yet applicable. Icelandic banks remain subject to existing prudential requirements on operational risk (Act No. 161/2002), notably on business continuity planning. - 98: Banks have developed business continuity plans that consider threats resulting from climate change-related events; the Natural Catastrophe Fund plays a key mitigating role. Banking supervision should further assess whether climate-related financial risks may have any additional specific potential impact on operations. ### Data, monitoring, and internal reporting (paragraphs 88–89) - 88: No specific requirements focusing on banks’ data on climate-related financial risks have been issued for setting up adapted data production and management infrastructure, including data processing and collecting relevant data from counterparties. - 89: There was no clear assurance that banks had adequate data aggregation capabilities or could collect accurate and reliable data, including relevant data from counterparties, at the time of the Iceland main FSAP mission. - 89: Much work is needed to reach a full-fledged data management framework enabling reliable and relevant data-reporting to banks’ boards and senior management, and to supervisors. Quantitative and qualitative metrics or indicators would assess, monitor, and report climate-related financial risks. ### Credit, market, liquidity, and other prudential risk management (paragraphs 90–96) - 90: As part of ESG, climate-related credit risks are covered by EBA guidelines EBA/GL/2020/06 on loan origination and monitoring; provisions specific to climate-related financial risks are less explicit. The CBI is not planning to give more specific clarifications to banks regarding implementation of this EBA guideline in Iceland. - 91–92: Banks’ adjustment of credit risk management processes considering climate-related drivers and risks have not yet been assessed; no thorough offsite supervision and onsite inspection on that front. Icelandic banks’ climate-related credit risk exposure cannot be clearly measured yet. - 93–94: Specific supervisory requirements or guidance on climate-related market risk are not yet applicable; banks are not explicitly required to identify how climate-related risk drivers could affect the value of financial instruments, evaluate potential risk of losses and increased volatility, or establish processes to control or mitigate impacts. Global exposure of Icelandic banks to market risk is limited. - 95–96: Specific supervisory requirements or guidance on climate-related liquidity and funding risks are not yet applicable; banks are not explicitly required to assess the impact on net cash outflows or the value of assets comprising liquidity buffers (HQLA). Issuance of green bonds by banks is at an early stage; pricing effects of green finance products on profitability warrant monitoring. ### Scenario analysis and supervisory expectations (paragraph 99) - 99: Banks have not yet been required to develop climate scenario analysis that reflects their risk assessment and risk objectives, but they are working on it. - 99: The CBI did not rely much on banks’ input when performing its first scenario analysis, which was mostly based on Credit Registry data. - 99: The CBI plans a bottom-up climate scenario analysis in cooperation with banks. Developments under Principle 12 in the 2022 BCBS principles offer guidance on supervisory assessment of banks’ scenario analysis: analyses should reflect relevant climate-related financial risks, employ a range of time horizons, and be subject to challenge and regular review. ### Key supervisory recommendations (paragraphs 100–104) - 100: Enhance the CBI’s internal organizational framework for oversight and supervision of climate-related financial risks. Clarify roles and responsibilities among Financial Stability, Prudential Supervision, and Conduct Supervision, with support from other departments. Consider a matrix of roles and responsibilities, an internal steering committee including management representatives, and designation of a climate expert as focal point. - 101: Develop supervisory assessment methodology, tools, and processes, considering existing and future EBA requirements for climate-related financial risks within the banking sector. Structure supervisory processes, tailor assessment methodology to Iceland, develop tools and databases, and draft internal procedures and/or guidance. This would help mitigate “key-person risk” from concentration of expertise within the CBI. - 102: Develop and refine adapted supervisory stress testing and scenario analysis on climate-related financial risks within the banking sector. Build on the outcome of the scenario analysis disclosed in March 2023, progressively enhance supervisory stress testing using NGFS and EBA scenarios, tailoring them or jointly developing national scenarios that incorporate Iceland’s specific climate risk drivers. Plan work with interim milestones as reaching the expected outcome may require several years. - 103: Bridge data gaps on climate-related financial risks within the banking sector. Determine the set of required banking data useful to scenario analysis and microprudential supervision, collect such data based on regulatory reporting requirements, and prioritize setting relevant data requirements including KPIs/KRIs and exposures. - 104: Engage the banking sector in a more proactive and thorough supervisory dialogue to strengthen supervisors’ and banks’ capacities to assess and manage climate-related financial risks. Set up an institutional communication policy with the banking sector and an adapted program of supervisory meetings at various responsibility levels to enhance information flow and support banks’ ownership and implementation of applicable requirements. *Source: 1islea2023005 - 83. The impact assessment process of climate-related financial risks on banks’ solvency has (PDF chapter).* ### 105. Disclose supervisory expectations to banks and provide guidance on implementation, ### 105. Disclose supervisory expectations to banks and provide guidance on implementation, ### Supervisory guidance and expectations - Disclose supervisory expectations to banks and provide guidance on implementation, corporate governance, and risk management of climate-related financial risks. - In addition to the package of EU/EBA regulations, targeted and proportionate national guidance would be useful. ### Assessing impact on business models and profitability - Assess the impact of climate-related financial risks on banks’ business models and profitability drivers. - The CBI should build on expected developments of identification, measurement, and assessment of climate-related financial risks in the coming years to be able to make an informed global assessment of the overall impact of such risks on banks’ business models, as well as banks’ profitability drivers and structure. - This is a medium- to long-term objective that requires prior implementation of reliable and relevant data collection, and thorough supervisory assessment of climate-related financial risks. ### Corporate governance, internal organization, and resources - Assess the adequacy of banks’ corporate governance, internal organization and resources, capacity, and internal control of climate-related financial risks. - The CBI should get evidence of appropriate and effective frameworks in place, as well as adequate staffing and expertise, at least within larger banks, in view of ordering preventive or corrective action, if needed. - The CBI would benefit from inputs provided by increasingly capable bank experts, managers, and heads of independent internal control functions on climate-related financial risks throughout regular supervisory processes. ### Risk management frameworks and processes - Assess the adequacy of banks’ risk management frameworks and processes for climate-related financial risks. - The CBI should closely monitor the progressive construction and capacity development of banks’ risk management functions and processes regarding climate-related financial risks, to ensure that risk management becomes adequate and effective. ### Data production, reporting, and supervisory data collection - Assess banks’ data production and reporting processes for climate-related financial risks and enhance supervisory data collection and analysis concomitantly. - Once data requirements on climate-related financial risks have been clarified, the CBI should assess the effective implementation within banks of reliable frameworks for related climate data production, quality control, and regulatory reporting. ### Credit risk drivers and mitigation - Assess the impact of climate-related risk drivers of credit risk, as well as the adequacy of adjusted credit risk management processes and mitigation techniques, to evaluate banks’ exposure to climate-related credit risk. - Building on enhanced banks’ data reporting and ICAAP reports, the CBI should challenge banks’ self-assessment of their credit risk exposure resulting from climate-related financial risks and complete a reliable supervisory assessment. ### Market risk, liquidity, and funding - Assess the impact of climate-related risk drivers of market risk, as well as liquidity and funding risks, to evaluate banks’ exposure to climate-related risks in these domains. - The CBI should prioritize the assessment of banks’ exposures to liquidity risk resulting from climate-related financial risks, leveraging enhanced banks’ data reporting and ILAAP reports. - The impact on banks’ long-term funding strategy would also deserve supervisory attention. - The CBI should clarify the eventual materiality of climate-related market risk. ### Operational, legal, and compliance risks - Ensure that climate-related risk drivers have been adequately incorporated into relevant operational risk management processes, beyond business continuity planning, that may be impacted. - In addition to the existing supervisory assessment of operational risk, the CBI should ensure that climate-related physical and transition risks are properly considered in all components of operational risk that may be impacted, in addition to business continuity planning. - The CBI should also pay further attention to banks’ potential exposure to legal and compliance risks, and liability costs, which might result from climate change issues. ### Scenario analysis, stress testing, and capital/liquidity adequacy - Assess the adequacy of banks’ climate scenario analysis and develop a supervisory dialogue with banks on related results to enhance the impact assessment on capital adequacy and liquidity. - The CBI should implement planned development of supervisory stress testing and scenario analysis. - The central bank should continuously improve and finetune relevant methodologies used to consider climate-related financial risks in order to improve the assessment of the adequacy of banks’ solvency and liquidity buffers. - In the long run, the CBI should get an informed opinion on whether banks’ net exposure to climate-related financial risks would specifically require additional Pillar 2 capital requirements and/or additional liquidity buffers. *Source: IMF staff (excerpts from the Iceland FSAP chapter on climate-related financial risks).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1islea2023005.pdf_