Japan’s FSA Flags Hurdles in Embedding Climate Risk into Banking & Insurance Frameworks

Key Takeaways

• Material Risk Acknowledged: Financial institutions are now treating climate change as a key strategic and governance issue, with internal structures evolving accordingly.
• Integration Challenges Persist: Quantifying and incorporating climate risk into traditional financial risk frameworks remains difficult due to data limitations and uncertainty.
• Transition Finance Trade-Offs: Supporting client transitions to net zero can temporarily increase financed emissions, complicating net-zero accounting and risk metrics.
• Client Engagement Prioritized: Institutions are engaging with high-emitting clients rather than divesting, offering solutions tailored to sector and maturity.
• FSA Maintains Dialogue: The regulator will continue working with institutions while recognising that climate responses should differ based on each firm’s characteristics.

Deep Dive

Japan’s Financial Services Agency (FSA) has released a new report capturing the latest efforts by the country’s financial institutions to manage climate-related risks, showing steady progress but also ongoing struggles with turning sustainability ambition into practical, measurable action.

The report, Practices and Issues on Climate-related Risk Management, builds on the FSA’s 2022 Supervisory Guidance on Climate-related Risk Management and Client Engagement and is based on dialogues held from mid-2024 to mid-2025 with approximately 20 institutions, including major and regional banks as well as life and non-life insurers.

The findings show that climate change is increasingly being treated as a material risk across the financial sector. Institutions are enhancing governance structures, adopting scenario analyses, and shifting their approach from divestment to engagement when working with high-emitting clients. But the report also makes clear that quantifying climate-related risks, and embedding them into traditional financial frameworks, remains a substantial hurdle.

Most institutions involved in the FSA’s engagement have now embedded climate considerations into their governance strategies. Dedicated sustainability committees have been formed, climate-related audits are becoming more common, and firms are beginning to link their long-term climate strategies with short-term business planning.

Still, the report flags several practical gaps, particularly around staff expertise, the alignment of business strategies with the Paris Agreement, and the difficulty of translating overarching goals into operational reality.

Risk Quantification Still a Work in Progress

Institutions have taken steps to assess climate risks using qualitative analysis, climate scenarios, and more granular, company-specific evaluations. But integrating those insights into traditional risk management frameworks continues to prove difficult.

Challenges include the high level of uncertainty surrounding long-term climate impacts, a lack of standardized non-financial data, and underdeveloped methodologies for assessing financial exposure to environmental risks. As a result, efforts to formally include climate risk within risk appetite frameworks or set hard limits tied to emissions remain limited.

A particularly thorny issue outlined in the report is the tension between transition finance and short-term emissions targets. Rather than walking away from high-emitting sectors, many institutions are opting to support their clients’ decarbonization journeys by offering advisory services and transition-focused financing.

This more constructive approach, however, comes with a trade-off, where financed emissions may temporarily rise as firms support carbon-intensive sectors through their transition. The report acknowledges that this is an unavoidable consequence of enabling real-world change, and one that institutions must navigate carefully while maintaining sound risk-return profiles.

The FSA says it will continue to engage with financial institutions on climate-related risk management and client engagement, with an understanding that responses should be tailored based on each firm’s size, business model, and client base. It also notes that domestic practices must continue evolving in step with global regulatory expectations and market developments.

The report paints a picture of a sector that is increasingly committed to climate risk management but still navigating the complexities of execution. Progress is being made, but so are new questions about how to account for risk, support clients, and move from policy to practice in a world where climate change is no longer a distant threat, but a financial reality.

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