Climate change will threaten banks’ profitability
Climate change risk will take its toll on bank profitability, report says
Banks need to change the way they plan for climate change risk because it will increasingly impact their bottom line. Rather than just viewing it in isolation as an environmental, social and governance consideration, they need to shift their mindset to seeing climate change as a threat to their own profitability, a new report warns.
“There is growing acknowledgement from central banks and supervisors that climate-related risks are a source of financial risk relevant for financial stability and soundness of financial institutions,” says the report from Scope, the ratings agency.
“For banks, this will require a shift in thinking – from being a corporate social responsibility issue to addressing the associated risks.”
The German ratings agency lists a number of ways that environmental factors could hit the banking sector’s profits and risk exposure. These include severe weather events leading to the repricing of sovereign debt; the increasing flood risk impacting mortgage portfolios; agricultural clients defaulting on loans; energy efficiency standards being applied to property and the automotive sector facing losses due to disruptive technology.
The changes are already happening. A group of 16 banks, co-ordinated by the Secretariat of the UN Environment Programme Finance Initiative (UNEP FI), is aiming to test the impact of climate change on their corporate lending portfolios. Weather events can influence levels of inflation, consumer spending, interest rates and other factors that have a bearing on a borrower’s ability to repay or the value of assets held in banks’ trading books.
There are three main areas of risk, Scope says: credit risks via lending and asset portfolios; funding costs driven by investor expectations; and capital requirements resulting from supervisory assessments.
“As disclosures improve, and supervisory assessments become a reality (in particular, stress tests) we see climate-related risks becoming a more tangible part of the credit process,” the note says.
In terms of banking business, the physical risks of climate change can damage property and impair the creditworthiness of borrowers and affect business continuity. The other, longer-term risk to overall banking profitability and rating comes from having to adjust to a lower carbon economy.
This will mean changes in policies, customer preferences and technologies. In time, this could lead to a new way of valuing assets and companies. While acknowledging that readiness for climate change is currently difficult to measure accurately, the report says banks need to start making changes now in anticipation of a new way of operating and being valued.
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