The Financial Implications of Climate Change
Climate change represents a prolonged shift in weather patterns, with severe economic consequences, particularly for businesses, that have become evident in recent years. For instance, the coffee industry has seen a steep price surge, largely due to poor harvests influenced by erratic weather. This change affects businesses in both export and import markets and ultimately impacts consumer costs. In Europe, for example, coffee prices have soared compared to last year.
The impact of recent extreme weather events also underscores the urgency of addressing climate change. Catastrophic storms, increasingly frequent and severe, are evident worldwide and are linked to climate change. Two notable recent storms—Typhoon Yagi in Vietnam and Hurricane Milton in the United States—highlight the significant challenge climate change poses to Vietnam's Net Zero commitments.
Climate-related risks for businesses and banks can be classified into two primary types: physical risks and transition risks. Physical risks refer to direct impacts from climate-related events like storms, which can damage buildings, inventory, and factories, directly affecting businesses. However, these physical assets also serve as collateral for banks, meaning that when business assets lose value, banks’ balance sheets also take a hit. Other climate impacts, such as rising temperatures, droughts, and wildfires, further exacerbate these physical risks.
The second type of risk involves the green transition—a concept that has gained significant momentum in recent years. To meet the increasingly stringent requirements of importing countries, businesses must adopt green practices, which entails substantial investment in green technologies and processes. This green transition affects companies' cash flows and loan arrangements, ultimately influencing the likelihood of non-performing loans in green lending portfolios. In Vietnam, these challenges are only beginning to unfold as both businesses and banks navigate the financial implications of green finance while awaiting a formal legal framework to define "green" criteria.
While green finance is a relatively new topic in Vietnam, Europe has already moved forward by setting standards for exports and imposing specific social criteria on businesses. This emerging requirement poses a clear challenge for Vietnamese businesses, signaling an urgent need to align with green standards.
A Pressing Need for Caution
Just a few years ago, the relationship between climate change and green finance as it pertains to businesses and banks was less apparent. However, recent developments, driven by scenarios like fluctuating coffee prices and extreme weather events, have illuminated the profound impact of climate change on business operations and, by extension, on banks.
Though green finance is now a frequent topic of conversation, existing loans in Vietnam do not yet meet green finance standards. This is partly due to the lack of a regulatory framework to distinguish green criteria, which complicates risk calculations for banks. If an incident occurs, it could reduce the value of collateral assets, increasing the risk of default and affecting non-performing loans (NPLs) and credit risk models for banks. Such developments inevitably influence interest rates and lending strategies within the banking sector.
In Europe, banks have traditionally reported loan products based on market, credit, liquidity, and operational risks. Today, however, banks are required to clearly disclose climate-related financial risks in their reports. Banks must now model scenarios to account for the direct effects of climate change on cash flow and balance sheet risks. This is a relatively new requirement, yet it has quickly become a critical issue. Approximately 30% of loans in Eurozone banks are currently exposed to systemic credit risks due to climate change, meaning that even banks not directly involved in green finance are still impacted.
When banks identify high NPL risks among businesses, their typical response is to reduce lending or increase interest rates. Should all banks take similar action, it would limit capital access for businesses, especially those vulnerable to climate change impacts. Additionally, this tightening of credit limits funding opportunities for businesses aiming to undertake green transitions, creating a challenge for both banks and businesses alike.
An equally critical issue in green finance is "greenwashing." Greenwashing refers to the practice of making false or misleading claims about the environmental benefits of certain products or services, which, in the context of green finance, can lead to significant financial risks. If improperly managed, green lending may turn into a green debt trap, where businesses acquire financing under the guise of environmental responsibility only to later struggle with repayment.
A recent example from China illustrates the dangers of greenwashing. A company there manipulated environmental assessment data to appear greener than it actually was, raising significant capital based on these claims. When the fraud was discovered, several reputable international banks and financial institutions that had invested in this company found themselves entangled in a greenwashing scandal. This case serves as a cautionary tale for the global financial sector, as greenwashing not only undermines the integrity of green finance but also exposes investors and lenders to substantial financial losses.
To navigate the climate-finance nexus, banks and businesses must adopt cautious yet proactive strategies. For banks, an immediate priority is to develop robust climate risk assessment frameworks that account for both physical and transition risks. Comprehensive climate risk disclosure, already a requirement in Europe, will likely become an international standard, making it essential for banks to understand and manage these risks.
For businesses, a green transition is becoming less of a choice and more of a requirement, especially for those with export ambitions. Companies that align with green standards are more likely to secure financing from green investment funds, which favor organizations committed to sustainability. However, businesses must also take care to ensure that their green credentials are authentic and verifiable to avoid the pitfalls of greenwashing.
In Vietnam, the path to integrating green finance is only beginning, with regulators, businesses, and banks all adapting to this emerging landscape. Establishing clear criteria for green finance will be essential for creating a supportive legal environment that facilitates sustainable investments. This will involve collaboration between government agencies, financial institutions, and businesses to define what constitutes green finance and establish standardized reporting practices. By doing so, Vietnam can foster a robust green finance ecosystem that supports sustainable development goals and strengthens resilience against climate change.
