Why Climate Change Concerns Your Banker
- We live in a world where banks themselves have become a crucial force in the fight against climate change.
- One of the main links is the fact that the main contributor to emissions (over 70%) is the use of fossil fuels and that companies in the fossil fuel sector receive substantial bank loans.
- The balance between the need to take urgent action on decarbonisation and the need to ensure stability during the transition phase makes the role of regulators such as central banks very important.
In the aftermath of the 2007/8 financial crisis, Hugo Chavez, the former president of Venezuela, said that if the climate was a bank, they would have saved it by now. He pointed out that in the hierarchy of urgent and important global goals, bailing out banks far outranks climate issues.
Eighteen years later, we live in a world where banks have themselves become a crucial force in the fight against climate change. In fact, major leaguers like JP Morgan Chase, Deutsche Bank, Barclays Group, Bank of America, and HSBC have become members of the Net Zero Banking Alliance.
This alliance represents more than 40% of global banking assets, which makes their net zero liabilities very significant.
You may be wondering what the connection is between banking risk and climate risk. One of the main links is the fact that the main contributor to emissions (over 70%) is the use of fossil fuels and that companies in the fossil fuel sector receive substantial bank loans.
According to an article in the Financial Times, the 60 largest private sector banks in the world have injected approximately $3.8 trillion into this sector from 2015 to date. It follows that if banks reduce their funding for these brown investments and increase credit to green energy and technology, emissions can be expected to drop significantly.
An obvious concern is whether there is a large enough pipeline of bankable green projects/investments to absorb the growing pot of green money.
A second concern is whether an extremely rapid exit from fossil fuel investment could destabilize not only the oil, gas and coal sector, but also the financial sector.
The balance between the need to take urgent action on decarbonisation and the need to ensure stability during the transition phase makes the role of regulators such as central banks very important.
In the Kenyan context, the Central Bank of Kenya (CBK) released its guidance on managing climate-related risks in October 2021.
The CBK’s guidance is built around the four pillars of the Task Force on Climate-Related Financial Disclosures (TCFD) publication dated October 2021, namely governance, strategy, risk management and indicators. /Goals.
A strong governance structure is certainly needed to ensure that an institution properly assesses climate risks and opportunities. To give this issue the attention it deserves, the CBK is bringing it squarely to the board table.
There may be a temptation to hire a climate director, but he cannot go it alone – the board must seriously consider climate issues and take ultimate responsibility for them. We wouldn’t be surprised to soon see separate and dedicated board committees responsible for ESG and climate issues.
The board is responsible for overseeing the development of a climate risk and opportunity strategy while senior management is responsible for implementation. Strategy formulation is informed by an understanding of climate-related risks in the business environment and the horizon of those risks.
This is why the devil is in the details when it comes to the risk assessment element. There are a myriad of risk factors surrounding the extent to which capital is deployed for brown versus green investments.
For example, if a bank has significant exposure to a carbon-intensive borrower, it should consider the credit risk associated with weaker performance or reduced market share due to adverse public perception, risk that the value of the borrower’s collateral will decline due to reduced demand for such assets and the risk of legal liability of being sued for sponsoring environmental damage.
In its guidance document, the CBK delineated the parameters of the risk management framework, but avoided being overly prescriptive. Institutions themselves must identify, measure, monitor, report, control and mitigate climate-related risks that impact their portfolios and operations.
The risk assessment process should take into account the materiality and likelihood of the potential impacts identified.
The comprehensive nature of climate risk assessment requires a data-driven approach which, in turn, assumes that banks have retained relevant information in a way that allows it to be easily retrieved and analyzed using of applications.
The risk assessment process also requires access to subject matter experts, as some of the data interpretation will inevitably be subjective.
Once a clear strategy is in place based on a thorough risk assessment, the next step is to implement the strategy and reliably track progress. This is where climate change measures and targets come in.
They are essential for accountability because, as they say, what gets measured gets done, so setting reasonable yet impactful goals is key. With allegations of greenwashing becoming more prevalent, banks need to think carefully about setting their goals to make their successes inviolable.
In the TCFD publication, we see some examples of measures used by banks to disclose their climate risks. For example, a bank can report its funded emissions and fuel mix over a number of years to demonstrate a greener trend.
Banks can also report their exposure to mortgaged properties that are in areas at risk of coastal flooding or severe droughts, etc.
In terms of target setting, lenders can commit to certain sustainable finance investment targets by 2030 or specify the level of investment in particular areas such as ecotourism or vehicle manufacturing electricity and charging infrastructure.
KCB #ticker: KCB, for example, has pledged to grow its green loan portfolio by 5% per year over the next five years and to stop lending to companies and projects that pollute the environment.
From an internal consumption perspective, a bank may also have green procurement goals, such as using a fleet of low-emission models, ensuring that tea and coffee are purchased from certified sustainable producers and the use of renewable energy wherever possible at its sites.
From the perspective of bank customers, banks can offer incentives to reward climate-conscious behavior, such as offering lower interest rates for financing solar energy solutions, leasing low-cost machinery emissions or the construction of energy efficient buildings.