Tackling Climate Lending Risks

Newly released software reveals and helps financial supervisors tackle transition risks in lending portfolios.

Additional contributors: CJ Yetman, Jacob Kastl

As we face the intensified impacts of climate change, there is growing urgency to mitigate transition risks to safeguard financial stability. Central banks, supervisors, and regulators need actionable tools to address the increasing complexity of climate risk management. While stress tests identify macro-level vulnerabilities across the financial system, they fall short in providing the detailed insights needed to assess the risk of individual banks and loanbooks. To meet this demand, RMI launched the pacta.multi.loanbook software package, empowering banking supervisors to analyze and measure alignment of lending portfolios with climate scenarios.

RMI’s pacta.multi.loanbook uses a bottom-up, physical asset-based, forward-looking methodology, and offers clear and actionable insights into the transition readiness and capabilities of banks. It is part of RMI’s Paris Agreement Capital Transition Assessment (PACTA), an open-source and free-of-charge software application that enables users to measure the alignment of financial portfolios with climate scenarios as well as analyze specific companies.

By incorporating the feedback of past and prospective users, pacta.multi.loanbook builds on years of experience supporting supervisors, central banks, and governments across different geographies globally. As an open-source and public software, every part of the analysis is auditable — in contrast to the many closed-source, black-box alternatives on the market. Prototypical versions of the software package have already supported industry-leading insights across geographies and regulatory bodies:

• In Europe, the banking sector provides 75 percent of lending in the Euro-area, yet only a small portion of its portfolios align with global climate goals. The European Central Bank (ECB), with PACTA’s technical support, showed that a staggering 90 percent of banks’ lending activities remain misaligned, and 70 percent of their net-zero pledges fail to reflect actual corporate lending behavior. This disconnect not only hampers global climate efforts but also exposes institutions to litigation risks as regulatory scrutiny intensifies.
• In New York, insurers’ investment portfolios show significant exposure to high-carbon sectors like coal, oil, and gas, posing clear transition risks. While many asset owners have pledged net-zero emissions by 2050, achieving this requires drastic shifts in production and investment patterns. Innovation in renewables and electric vehicles reshapes these industries, creating both risks and opportunities.
• In Brazil, asset managers allocate up to 30 percent of equities and bonds to climate-relevant sectors such as fossil fuels and steel — substantially higher than the global average of 5 percent. Production plans for these sectors remain critically misaligned with net-zero scenarios, heightening risks of financial loss during a sudden transition. Meaningful engagement between asset managers and corporations could drive Brazil’s low-carbon transformation.
• The European Insurance and Occupational Pensions Authority report (EIOPA) cited PACTA’s foundational work in its recommendations to increase capital requirements for insurers holding fossil fuel assets. The report emphasized the value of forward-looking approaches over backward-looking risk assessments, underscoring PACTA’s critical role in influencing regulatory strategies.
• Similarly, the European Banking Authority (EBA) has mandated the disclosure of physical asset-based financial exposure to climate-critical sectors relative to future climate transition scenario values in its current ITS Pillar 3 template 3 disclosure requirements. While the approaches of EIOPA and the EBA differ in direct capital requirements versus market discipline via disclosures, the impact of forward-looking, physical asset-based approaches on financial regulation and supervision are becoming ever more evident.

pacta.multi.loanbook’s approach

Sector-Level, Forward-Looking Insights

pacta.multi.loanbook provides a system view of climate risks by analyzing loanbooks at the sector level, identifying key focus areas for further investigation. The financial risks associated with climate change are concentrated in specific high-emitting sectors such as power, oil and gas, automotive, and heavy industry, making sector-level insights invaluable. By understanding the alignment of these sectors with global climate goals, supervisors can better prioritize their efforts toward financial institutions, ensuring resources are directed toward the areas with the greatest risk exposure or misalignment in these sectors.

The forward-looking nature of PACTA allows supervisors to assess not just where financial institutions stand today but also their projected alignment based on asset-level production data. This data provides a clearer picture of transition pathways than backward-looking emissions data. For instance, production forecasts for power plants or automotive manufacturing can reveal whether companies are aligning their capacity buildouts or phase-outs with the Paris Agreement.

Loanbook-Level Insights

The PACTA approach progresses from sector-level analysis to loanbook granularity, allowing financial supervisors to isolate specific climate risk hotspots across the banks and lending portfolios that they supervise. This level of detail is essential for identifying and engaging with the individual banks driving misalignment, particularly in cases where stated net-zero commitments fail to align with actual production or transition plans.

Loanbook-level analysis helps supervisors evaluate the transition capabilities of companies by linking forward-looking production data to their long-term strategies and actions. By leveraging PACTA, users can identify not only which banks are most misaligned but also the specific drivers of that misalignment — whether it’s continued investment in fossil fuels, insufficient diversification, or delayed capacity phase-outs.

Explore PACTA’s supervisory software

RMI’s newly released pacta.multi.loanbook lets supervisors assess their climate transition risks and has been used to support large-scale analyses, such as that published by the ECB earlier this year. For support in running a PACTA supervisory analysis, please contact us at pacta@rmi.org.