In a report released by Ceres and CLIMAFIN titled “Financing a Net Zero Economy: The Consequences of Physical Climate Risk for Banks,” the companies outline detailed recommendations to guide the banking industry in handling the physical risk posed by climate change.
Both Ceres and CLIMAFIN are organizations focused on building a sustainable future for the financial industry. To develop the report, the two companies used natural catastrophe and credit risk models adjusted for climate effects, downscaled macroeconomic data, and publicly available information on syndicated loans from major U.S. Banks.
“There is no longer anything atypical about the intensity or frequency of climate-induced disasters,” the report stated. “They will continue increasing in a nonlinear fashion, and the resulting economic and financial impacts will not be short term. Entire areas will become uninsurable, and assets will face revaluation; banks will see both a higher probability of loan defaults, and higher losses in the event of default.
“For banks and credit unions with more concentrated geographical footprints, these risks could be existential – and a wave of distress among these smaller institutions could, in itself, be systemic. The interconnectedness of our financial system means stress can spread quickly, amplifying and transmitting disruption throughout the economy. Our nation’s largest banks should not assume, as they did in the 2008 crisis, that they are insulated from the reckless decisions of their peers, or nimble enough to avoid destabilizing losses from climate damages.”
The report examines 60,737 syndicated loans from 28 U.S. banks, totaling $2.2 trillion and finds that, in the worst-case scenario, the annual value-at-risk from physical climate impacts could reach 10 percent, even if adaptation measures are taken. Climate physical risks include damages to physical assets, natural capital, and human lives that result in losses of productive capacity, affecting output and GDP. Damage from physical climate impact can generate credit, market, and systemic risk.
Furthermore, the report shows two-thirds of physical risk is a result of indirect economic impacts of climate change, such as supply chain disruptions. The largest source of direct risk is coastal flooding driven by sea level rise and stronger storms.
Though the report is primarily a guide for banks to measure and mitigate their exposure, it also highlights the fact the private sector cannot handle the situation on its own. Regulators like the Federal Reserve, the Office of the Comptroller of the Currency, the National Credit Union Administration, and state banking officials also should take climate change risk into account in their supervisory responsibilities. One example given is installing climate-related stress tests for individual financial institutions, something already being implemented by the European Central Bank.
However, Ceres also urges banks to begin acting on their own to mitigate risk rather than waiting for regulatory bodies to mandate such actions.
Ceres breaks its guidance into four categories, then makes 13 recommendations across these subjects and suggests financial institutions publicly commit to work on incorporating them into their risk analysis and planning procedures within the next year.
These are:
- Assess and measure climate risk.
- Assess all elements of climate risk and opportunity.
- Measure the current impact of natural disasters on the value of financial assets.
- Project the future cost of climate change.
- Perform climate stress tests.
- Collect asset-level data about exposure and loss vulnerability.
- Take action.
- Build connections with external experts.
- Integrate climate into product and service pricing.
- Engage clients on physical risks.
- Capitalize on opportunities.
- Understand the changing insurance landscape.
- Focus on adaptation projects to mitigate credit risk.
- Develop innovative adaptation financing solutions.
- Advocate for smart financial regulatory and policy actions on adaptation.
- Meet the moment.
- Set and disclose financing portfolio targets, including aligning strategies with the goals of Paris Agreement.
“Right now, someone’s home is melting, a family is tossing its things in the car to flee a tornado or a wildfire, a person is being led to a shelter from the burning heat,” the report stated. “The events of this summer have laid to rest the idea that climate induced damage is abstract, something future based that might or might not happen. Even speaking of it as a risk suggests that the cost and physical damage associated with climate events is something for another day, another government, another group of policymakers, or another set of business leaders to tackle. This summer we see that the costs and damage are with us now; they are not matters for another day. Solutions are no longer for just the future; they are needed now.”