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Banking

Banks must act now to navigate the effects of climate change

Banks must act now to navigate the effects of climate change 3

Banks must act now to navigate the effects of climate change 4By Peter Grant, President and Chief Commercial Officer of OakNorth Credit Intelligence

There will continue to be a symbiotic relationship between climate change, credit risk management and commercial lending going forward, and banks across the United States, and indeed globally, are keeping a keen eye on this.

According to a survey conducted at OakNorth’s latest Climate Consortium – a group of innovative, climate-forward institutions driving commercial lending’s approach to climate risk and opportunity – 59% of banks in attendance have started creating a plan to mitigate climate risk in their commercial loan book.

These banks are vetting the different risks associated with climate risk, with 74% of Consortium attendees saying transition risk is a top priority compared to 26% who prioritize physical. When examining transition risk, 50% of the Consortium are concerned about direct impact sectors (i.e.cement, steel, coal).

In order to assess how material and manageable their climate change exposure is, commercial banks will need to develop frameworks, gather more data, and conduct quantitative and qualitative scenario analysis.

The major risks

There are two specific climate risks banks are focusing on: transition risks and physical risks.

Transition risks are a result of the adjustments towards a low-carbon economy. Factors influencing this adjustment include climate-related developments in policy and regulation, the emergence of disruptive technology or business models, shifting sentiment and societal preferences, or evolving evidence, frameworks, and legal interpretations.

Low carbon policies and technological transitions towards mitigating climate change could affect credit risk in loan books and lending strategies.

Physical risks consist of extreme weather events such as hurricanes, fires, floods, heatwaves and other climatic patterns, including changes in precipitation, rising temperatures, rising sea levels and desertification.

These events pose risks of individual damage incidents, disruption, and chronic shifts in labor, capital and other business drivers.

The time to act is now

Banks are realising they need to act fast to navigate the effects of climate change, and those that aren’t, will fall behind. Most notably, banks are looking to get ahead of the curve when it comes to pending climate change-related regulations and consumer demand.

According to Mark Levonian, former senior deputy comptroller for economics at the Office of the Comptroller of the Currency and a member of OakNorth’s Advisory Board, the banking industry will likely see formal climate change-related guidance from supervisors within the next year, with formal regulation following thereafter.

With the pressure banks are receiving from their boards, examiners, and investors — along with the pace of technological disruption and changing consumer demand — banks have started acting now instead of waiting for climate change regulations to come.

At its most recent Climate Consortium, OakNorth was joined by Dr. Michael Lenox, Tayloe Murphy professor of business administration, senior associate dean, and chief strategy officer at the Darden School of the University of Virginia. Dr. Lenox, said: “While this change may have initially been driven by regulation, the market dynamics in terms of consumer demand and technological evolution are now far-out-stripping any regulatory response.”

He demonstrated this with an example of the original internal combustion engine automobile. When it initially came to market, the engine was seen as a solution to an environmental issue caused by the accumulated manure from horse-drawn carriages in the street. Nearly 100 years after the advent of the internal combustion engine, problems caused by the engine are well-documented, paving the way for increased consumer demand for electric vehicles.

In 2019, electric vehicles represented just 2% of all new car sales in the United States. A year later, it doubled to 4%. In 2021, it doubled again to 8%. This year it’s forecast to — yet again — double to 16%. So, it’s not too big a leap to assume that, within the next decade, most car sales will be electric – especially given the push we’re seeing from state regulators in states such as California where I live.

Building climate confident teams

One of the first steps banks can take to navigate the effects of climate change is to work on developing a loan-level understanding of the businesses they’re lending to. Developing a loan-level understanding starts with having the right people, processes and technologies in place in order to build what we refer to as “climate-confident teams”.

Climate-confident teams are able to work with customers and have conversations about the risks of climate change and the changes they can and should be making to their business models to address them.

These teams can then use the data from these client discussions to help enhance the decision-making process. Banks hoping to be trusted advisors to the businesses they lend to must prioritize working together so these businesses understand their climate sensitivity and vulnerability and how that could impact their creditworthiness in the future.

Vulnerability of data centers and other critical services to extreme weather

Vetting operational risks is essential. Banks must develop a clear understanding of their existing operations, the entities performing such operations, the locations where these operations take place, any backup sites, and any cross-sector dependencies.

The banking industry needs flexible, technology-based solutions that can dynamically adapt to new data and enable the analysis and modeling of operational risks, hazards, and vulnerabilities.

The biggest opportunity for commercial bankers in a generation

Climate change represents an opportunity for commercial bankers to influence positive change and be part of the solution, while generating significant growth in their loan books, and supporting their customers in the transition to the green economy. Armed with the right data, climate change will give relationship managers and the front line the opportunity to become trusted advisors to businesses and play a leading role in helping economies around the world achieve their net zero commitments.

About the Author:

With a career spanning 20 years in enterprise software, Peter has led sales at several iconic companies contributing to their explosive growth and IPOs, as well as helping to drive the cloud revolution. He started his career at Oracle Siebel, where he helped grow revenues from $100m to $2bn, taking the employee base from 350 to 8,000 in just four years. He later joined salesforce.com as managing director of the UK business, and was only the 10th employee, but helped grow the business’ revenues from $50m to $1bn under the leadership of Marc Benioff. He then returned to working with Tom Siebel, joining C3.ai, where he held an executive leadership position responsible for all go-to-market across the US & APAC, reporting directly into to Tom. Based in San Francisco, Peter is OakNorths President and Chief Commercial Officer leading its revenue and growth, working directly with OakNorth’s co-founder, Rishi Khosla

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