The UN Environment Programme estimates the worldwide cost of adapting to the impact of climate change is expected to grow to $140-300 billion a year by 2030, spiralling to $280-500 billion by 2050. 70% of central banks and regulators consider climate change a major threat to financial stability and as a result, we are seeing the inclusion of climate considerations in stress tests for banks and financial institutions. In the same way banks’ liquidity is stress tested to check their vulnerability in another major financial crash, banks’ sustainability models are now being tested to see if they can withstand environmental crises.
What are the risks?
Banks come at the issue of climate change from two angles. The first is risk and the challenges that climate change poses. For example, it might be a bank’s credit risk limits for mortgage customers that live in areas threatened by flooding, or other adverse weather conditions caused by climate change. The greater the lending to customers in these potentially high risk areas, the greater the risk to the bank. It might also be corporate credit risk levels – how much the banks lend to companies with questionable sustainability outlooks (e.g. oil and gas companies).
The second angle is revenue generation. Just how they can turn climate change opportunities to their own financial advantage, or build into their own sustainability business models. For example, many banks have developed a ‘green mortgage’ – it will give customers an additional loan at a good interest rate on top of their mortgage to upgrade their boiler to a more environmentally friendly model. So using their financing as a way of helping customers to become more sustainable, which in turn impacts the sustainability and longevity of their own business models. Smart.
Where do banks even start?
So where do banks even start? How can they mobilise a programme that addresses this whole climate change issue? Here are our top four tips for financial companies to follow:
- Risk management and stress testing – banks need to update their risk frameworks to prepare for the Bank of England’s 2021 biennial exploratory scenario, which aims to test the resilience of business models of banks, insurers and other financial institutions to climate related risks, to gauge the scale of adjustment they need to make in order for them to remain resilient.
- Opportunities – considering revenue generation opportunities around climate change is also important. This might involve assessing the possibilities of developing green products.
- Company footprint – this involves looking at the business’s own carbon footprint and coming up with solutions to reduce it.
- Measuring and reporting – this could mean establishing a baseline for financed emissions, setting Paris aligned targets to reduce them and embedding carbon reporting into BAU finance processes.
As with almost everything else in business these days, much of a climate change programme needs to be driven by data – robust and accurate emission data combined with financial data. That and training and robust change management – if your workforce is not on board with your climate change programme, it simply won’t work.