Climate change is a grave global issue that will continue to impact us all. When looking at the banking industry and commercial lenders specifically, climate change presents both significant challenges and significant opportunities.
When it comes to managing climate risk, one of the biggest challenges facing commercial lenders is data. Borrower data, especially for climate risk in commercial lending is often incomplete, outdated, or simply unavailable and requires manual data entry which often results in duplication of data and errors. Data, if at all available at a granular level, is usually stored across multiple disparate systems (and in folders and files of bankers) with no consistent view of data. As more and more data is created, additional data challenges arise around: variety, velocity, veracity, and volume. In order to effectively examine the effects of climate change at the counter-party and exposure level, banks will need to gather much more granular data than they currently have. Banks that are more aggressive in trying to develop data taxonomies and mine the data they have, will have a good feedback loop into the policy process.
Lack of consistency
Many financial services companies voluntarily assess and report their operations against commonly agreed frameworks such as the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), the Partnership for Carbon Accounting Financials (PCAF), the Global Reporting Initiative (GRI), and the standards of the Sustainability Accounting Standards Board (SASB). A primary concern however, has been the resulting lack of standardization across definitions, data, and disclosures, leading investors and regulators to seek more consistency and “decision-useful” information.
In order to continue being a trusted partner to borrowers, commercial banks need to work with borrowers to help them understand their climate sensitivity and vulnerability, and how climate change may impact their future decarbonization plans that impacts credit worthiness. However, as climate change is still such a new area for the industry, it’s hard for banks to build climate-confident teams. So many new skillsets are required for commercial lenders in terms of data science, new modelling techniques, understanding the metrics to track and how some of these new green technologies work, etc. and there’s simply not enough people in the industry (yet) with the depth and breadth of expertise needed. Banks should therefore be coaching their front line to have transition-related conversations with clients, providing them with the right questions to ask for different industries and sub-sectors, and using the data from these discussions as one of several inputs to help inform decision-making.
Fast-evolving transition risks
Climate risks are highly uncertain and non-linear and can affect multiple risk categories simultaneously, so are incredibly difficult to model. Balancing very long-term horizons with immediate risks makes it challenging to develop strong foresight – especially when it comes to transition risks such as policy changes, technological disruption, carbon taxes, changing consumer demand, etc. Firms will also need to consider a broad range of scenarios with sufficient granularity to enable them to adequately assess the risks of meeting their risk management objectives and wider climate change targets.
Looking forward, in our view by 2025, the amount of lending which will need to be done every year in the US to support decarbonization, will be just under two times the volume which was done via the Payment Protection Programme (PPP) in the US during COVID. This represents a huge opportunity for the banks that are able to get on the front foot and address the points raised in this article.
The blog has been authored by Yugal Yadav, Director, Product – Climate Change Risks and Opportunities at OakNorth.
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