Governance, risk & compliance
targets into law, with new legislation being proposed to cut emissions by 55% by 2030. National governments are following suit. For banks, this means operational changes to tackle their own emissions, but for the financial services industry there is a much more immediate consideration – what does action on climate risk mean for their lending activities?
“Climate change is increasingly contributing to
society’s exposure to a range of acute and chronic physical risks,” says Anne-Sophie Castelnau, the new head of sustainability at Dutch bank ING. “These risks and the financial implications attached will inevitably impact both our clients and our balance sheet, hence a critical process is required to assess these risks and integrate them into our overall risk management framework. You can’t look at financing anymore without also looking at climate risk.”
A rational view of climate risk For banks, there are two kinds of climate risk – physical risks and transition risks. Physical risks are those that arise from the tangible effects of climate change, including extreme weather events or rising sea levels, on business operations, workforce, markets, infrastructure, raw materials and assets. Transition risks result from the policy, legal, technology and market changes occurring in the shift to a lower-carbon global economy, which could include carbon taxes or restrictions on land use. “Transition risks could result in stranded assets, or even markets, by the loss of value of assets that are no longer part of a more sustainable world,” Castelnau explains.
“For ING, managing climate risks covers both physical risks and transition risks,” she continues. “To get an understanding of our exposure to climate risk and the impact on our business, we are focusing our analysis on those sectors likely to be most severely affected by climate change and advancing our work on the identification and covering of climate risk. All relevant risks should be considered in our risk management framework and integrated into a forward-looking approach.” That’s especially true given new regulation coming round the bend. The 2021 Biennial Exploratory Scenario (BES) by the Bank of England will be devoted to the financial risks of climate change. From this, new requirements could emerge that would force many institutions to ramp up their capabilities for the collection of data about physical and transition risks, modelling methodologies, risk assessment and risk management. At present, many European banks fail to disclose risks beyond their most carbon-intensive clients, according to a survey by the European Banking Authority (EBA). “Climate risks are relatively new risks that require different and additional information to
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be assessed,” says an EBA spokesperson. “This forces banks to also update their internal data infrastructures accordingly. There are different dimensions to consider when comparing climate risk data to the one used for standard financial risk assessment. Regarding data availability, some of the key information like carbon footprints or transition strategies are not yet fully available and, therefore, in many cases this leads to using proxies which are less accurate. Historical observations are not good predictors for future patterns and cannot help in bridging these gaps.”
With new legislation proposed to cut emissions by 55% by 2030, what does this mean for the financial industry?
“To get an understanding of our exposure to climate risk and the impact on our business, we are focusing our analysis on those sectors likely to be most severely affected by climate change and advancing our work on the identification and covering of climate risk.”
In May, the EBA published the findings of its first EU-wide pilot exercise on climate risk, for which the main objective was to map banks’ exposures to climate risk – and provide an insight into the green estimation efforts banks have carried out so far. “In general, the experience gained with the pilot exercise helped us to understand where banks stand in terms of data capabilities to assess climate risk,” the EBA source explains. “In this regard, banks are making a significant effort in expanding their data infrastructures but there is still a lot of work to be done, especially concerning client specific information at activity level. Banks are more aware now of the significant challenges needed to measure and assess climate risks and that additional effort should be put in terms of governance, resources, analytical tools and data infrastructure to make their portfolios less carbon-intensive and more resilient to climate risk shocks.”
58%
Exposure of 29 banks to non-SME corporates are allocated to sectors that might be sensitive to transition risk.
The European Banking Authority 43
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