climate risk: its implications for financial institutions
by John Thackeray The defining issue and top global emerging risk of 2020 is climate risk, which has been gaining a sense of urgency with major implications for financial institutions. Climate change can no longer be viewed in isolation as a reputational risk but must be seen and addressed as a financial risk that needs to be integrated into existing risk management frameworks. Climate risk is a “transverse” risk that can extend its reach into existing risk stripes. As climate risk manifests itself through existing risk stripes, climate change can also heighten credit risks for banks, as demonstrated by the recent PG&E bankruptcy. Banks need to consider how climate-driven financial risks can be embedded into current financial risk management frameworks. Regulators have been influenced by increasing interest in both the impact and implications of climate change as a result of public awareness and the failure of governments and the United Nations to reach substantive and collective agreement. In this vacuum, central banks are starting to lead by example by including climate-related risks in their evaluations, leading to an escalation of policy pronouncements which are likely to adjust more rapidly with an intensification in the climate change debate. Increased cooperation is evidenced by The Network of Central Banks and Supervisors for Greening the Financial System (NGFS), an international cooperation and collaboration between central banks and regulators with a main aim to address the financial sector’s attempts to achieve the Paris climate goals. Since climate change continues to have huge economic and political implications, regulators are pushing financial institutions to take climate risk issues in their analyses of country risk and sovereign ratings which will filter down into individual counterparty ratings. The IMF’s new chief, Kristalina Georgieva, pioneered green bonds in 2008 while at the World Bank. She is discussing whether assigning different risk weightings to assets that are more or less green is fostering an important discussion that engages the financial community. Recently the US Democratic Senator Brian Schatz of Hawaii introduced a bill that would direct the Federal Reserve to subject large banks to do stress tests measuring their resilience to climate-related financial risks. The proposed Climate Change Financial Risk Act of 2019 underscores worries among policy makers over the risk posed by the financial system by the continuous and sustainable weather events which continue to plague the continental United States. Accountability has become the weapon of choice, with financial institutions having signed up to laudable climate principles (i.e. the Equator principles); they will need to demonstrate with actionable examples how they are adhering to such principles. Shareholder and social media will apply a lens which may mean Boards will need to become climate literate at a faster pace.
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Intelligent Risk - April 2020
