Following inspections carried out throughout 2025, Finanstilsynet, the Danish financial sector supervisor, released a report highlighting areas of improvement in how Danish banks identify, address, and manage credit risks related to environmental, social, and governance (ESG) factors.
The report is not tied to the performance of a specific institution, nor does it imply gaps across all institutions – it provides observations and highlights good practices across the sector.
Legal basis and main actions
The legal basis for the treatment of ESG risks stems from the Executive Order on the Management and Control of Banks, the Financial Business Act, as well as EBA’s Guidelines on the Management of ESG risks.
Current regulation allows for the management of credit risks related to ESG to be addressed in a proportional way. This means that, while all credit institutions need to identify and address material risks in their credit policy and business operations, the management of these risks can be adjusted based on the institutions’ size, risk profile, and business model.
Institutions are also required to carry out a materiality assessment related to ESG risks at least annually, with the exception of small and non-complex institutions, which need to carry out the assessment every other year. Importantly, all institutions should update the assessment when material changes occur.
Main actions for credit institutions stemming from Finanstilsynet’s report and obligations are included below.
Action 1
Improve the operationalization of physical and transition risks into credit risks
Credit institutions are obliged to identify ESG-related credit risks based on their business model, risk profile, and other risks. Finanstilsynet lists physical risks (such as extreme weather events or changes in the marine environment) and transition risks (such as regulatory changes or restrictions in the use of fossil fuels) as an essential part of this assessment.
Rather than remaining at a high-level stage, and given their limited probability but high impact, institutions should ensure that physical and transition risks are systematically addressed and translated into borrower and portfolio-level credit risk assessment. Depending on the customer profile, this process and its relevance would look different across institutions.
Action 2
Use scenario analysis to help avoid risk underestimation
Using scenario analysis over the short, medium, and long term as part of portfolio-level assessments of ESG-related credit risks can be a useful approach to bridge the uncertainty and avoid underestimation.
For credit institutions, it is important to be aware of outcomes that go beyond mild effects, to use latest scientific research in the calculations, and to be aware of current and future legislation and changing customer preferences as important factors influencing the assessments.
Finanstilsynet has highlighted the importance of choosing scenarios for credit management as part of the management and governance processes. Scenario analysis should be seen not just as a high-level exercise, but also as a tool to support decision-making and better understanding of the impact of climate change on credit exposures.
Action 3
Integrate ESG-related credit risk into credit policy and business procedures
The findings from assessing ESG-related credit risks may inform institutions’ decisions on their risk appetite, procedures for analyzing specific ESG-related credit risks at different levels, and the types of financing that the institutions may wish – or not wish – to provide as a result of ESG-related credit risk levels.
These considerations need to be part of credit policy and business procedures. When institutions’ portfolio analyses show significant ESG-related risks, then internal analysis in business processes and identification of relevant ESG data points would be necessary.
On the topic of ESG data points, Finanstilsynet mentions good correlation between the data points reported as part of the VSME and the identification of ESG-related credit risks.
Action 4
Separate credit risk from broader sustainability elements
A customer sponsoring a local eco-club and being exposed to flooding risk at their planned new property are two examples of an important distinction that institutions need to make. While the presence (or absence) of the action in the first example does not affect the institution’s financial risk, the circumstances in the second example would constitute a credit risk, as they may affect the customer’s ability for repayment, earning capacity, or business model.
Aside from making this distinction, institutions should devote resources to customer relationships where significant ESG-related risks have been identified. This would help to get a better understanding of whether the case at hand matches the institution’s risk appetite, and enable appropriate risk management actions to take place. In a climate-related scenario, the institution could analyze the customer’s transition plan and planned implementation to inform its decision about moving forward with the customer.
Action 5
Strengthen competence, communication, and internal controls
Relevant employees must be equipped to identify, analyze, and communicate about ESG-related credit risks. To help this process, Finanstilsynet highlights that institutions have identified internal training programs that range between details on differentiating broader sustainability from ESG-related credit risks and customer case studies to uncovering ESG-related credit risks during dialogue with customers.
On the latter, communication and dialogue with customers is essential, particularly in cases where significant ESG-related risks have been identified. Customer dialogue on ESG matters has been seen as positive.
The analysis shows that institutions’ first and second line of defense in connection to ESG-related credit risks are in development, while the third line of defense is more prominent. These internal mechanisms are necessary for ensuring quality of the risk analysis and adequate implementation of credit and business policies and procedures.
The bottom line
Finanstilsynet analysis shows both progress and areas of improvement for institutions’ capabilities to address ESG-related credit risk. This aligns with similar findings from the analysis of the first CSRD reports in the Danish financial sector and Finanstilsynet’s views on the outcomes.
Notably, this report focuses on the climate aspects of ESG, which in the future may be expanded to look into social considerations in a greater level of depth, especially given that human rights due diligence is also an area of continuous development for the Danish financial sector as a whole.