Over the last 12 months, risk organizations have continued to transform, under the influence of three main drivers. Individual banks must be sure about the role they want to play and identify the client segments and industry sectors where they can add the most value. A leading international bank aimed to increase its share of climate markets. The bank aimed to assess climate risk for each of its 2,500 counterparties on an annual basis, and its solution had to be sufficiently simple and scalable for individual loan officers to use on counterparties of all sizes. Consider some of the staggering costs of dealing with climate change: No surprise then that world leaders, for the third consecutive year, ranked environmental threats as the biggest risks to the world, according to the World Economic Forum’s latest Global Risks Report.9, The banking industry is not immune, given the potential wide-ranging consequences from climate change. The Paris Agreement’s central aim is to strengthen the global response to the threat of climate change by keeping any global temperature rise this century well below 2 degrees Celsius above preindustrial levels and to pursue efforts to limit the temperature increase even further to 1.5° Celsius. Batten et al. Is the banking industry taking enough proactive measures on climate change? However, in the event of an economic slowdown, the rate could go as high as 7.25 percent. Climate risks must be addressed in the same manner as other risks facing the financial sector. Management of climate change at the Board level is cascaded to Group Executives. Climate considerations should be deeply embedded in risk frameworks and capital-allocation processes. I do hope the evidence for action is compelling. These require banks to identify, measure, quantify, and monitor exposure to climate risk and 1 Bundesanstalt für Finanzdienstleistungsaufsicht. Many investors, responding to their clients’ shifting attitudes, already consider environmental, sustainability, and governance (ESG) factors in their investment decisions and are channeling funds to “green” companies. As the understanding among financial institutions of the risks and opportunities imposed by climate change becomes more… 7 Economist Intelligence Unit, “The cost of inaction: Recognising the value at risk from climate change,” 2015. By Amnon Levy and Frank Freitas. There are material risks on a ten-year horizon (not far beyond the average maturity of loan books), and transition risks are already becoming real, forcing banks, for example, to write off stranded assets. Reinvent your business. 2 National Aeronautics and Space Administration, NASA, “Climate Change: How Do We Know?,” Accessed May 20, 2019. Banks should assess their: Loan/customer portfolios. Regulation timeline 1Bundesanstalt für Finanzdienstleistungsaufsicht. Since regulators are prioritizing stress testing for the coming period, acquiring the necessary climate-modeling expertise and climate-hazard and asset-level data is an urgent task. Climate-related financial risks refer to the set of potential risks that may result from climate change and that could potentially impact the safety and soundness of individual financial institutions and have broader financial stability implications for the banking system. McKinsey Insights - Get our latest thinking on your iPhone, iPad, or Android device. And, some, like ING Bank in the Netherlands, are also taking specific steps in their lending businesses to impact global agreements such as the Paris Accord on climate control.16, Typically, banks have addressed climate change from a corporate social responsibility perspective rather than a risk management agenda.17. 19 Oliver Wyman, “Banks Move Toward Better Quantification of Climate Change Risk,” Press Release, September 12, 2018. However, by including climate-related risks as one of the key risks to banking in their Supervisory Priorities for the second year running, the ECB has shown a clear desire to engage with banks to understand how they are incorporating climate-related issues into their risk-management systems. Climate change has become the defining challenge of our times.1 There is increasing evidence that climate change is real.2 Its adverse impact on the environment, human life, and the economies is undeniable. The European Central Bank (ECB) today published its final and amended guide on climate-related and environmental risks following a public consultation. Ratings agencies, meanwhile, are incorporating climate factors into their assessments. 10 Riccardo Colacito, Bridget Hoffman and Toan Phan, “Temperature and Growth: A Panel Analysis of the United States,” WP 19-09, March 30, 2018. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the "Deloitte" name in the United States and their respective affiliates. already exists in Saved items. Many institutions have decided not to serve certain companies or sectors or have imposed emissions thresholds for financing in some sectors. Are there gender differences in banking behavior? In this uncertain environment, banks must act on two fronts: they need both to manage their own financial exposures and to help finance a green agenda, which will be critical to mitigate the impact of global warming. "Climate risk assessment is key to the goal of aligning the banking industry with a sustainable and equitable global economy in the 21st century, which becomes even more relevant today as we need to build back better after the COVID-19 pandemic," said Eric Usher, Head of UNEP FI. That survey indicated that climate risk management is generally in its infancy, but that firms want to learn and improve their practices. Physical Risks That may Arise from Shifts in Climate Patterns Banking regulators, and academic researchers generally agree that physical risks such as increased 1. on reporting of climate risk in 2009 by 163 financial services companies to the Carbon Disclosure Project ... management of climate change through financing mechanisms. Banks should integrate climate considerations into financial risk management. Updating the cost assumptions for BEIS’s energy efficiency modelling,” UK Department for Business, Energy & Industrial Strategy, April 2017; assets.publishing.service.gov.uk. risk management frameworks. F rom the analysis of the 2019 EY Global Climate Risk Disclosure Barometer, overall the banking sector performed well.The sector scored higher for both quality and coverage of climate-related risk disclosures, when compared to the average. 11 Michael S. Derby, “Fed Readying Financial System for Climate-Change Shocks,” The Wall Street Journal, May 7, 2019. Banking operations. 18 Nov 2020; Download; Risk Management; AI & Risk Management: enabling factors, use cases and future challenges. The Bank of England has continued to emphasise that climate risk is a strategic priority and the Prudential Regulation Authority (PRA)’s 2020-21 Business Plan clearly sets out that climate change brings financial risks that need to be managed now. Press enter to select and open the results on a new page. Banks should nominate a leader responsible for climate risk; chief risk officers (CROs) are often preferred candidates. Disruptive physical impacts will give rise to transition risks and opportunities in the economy, including shifts in demand, the development of new energy resources, and innovations arising from the need to tackle emissions and manage carbon, as well as necessary reforms in food systems. cookies, Climate risk and response: Physical hazards and socioeconomic impacts, McKinsey_Website_Accessibility@mckinsey.com. 12 Jana Randow and Piotr Skolimowski, “Central Banks Are Thinking Greener as Climate Change Hits Policy,” Bloomberg.com, April 2, 2019. Without a doubt, climate change is a source of financial risk and a risk-management question with direct impact on the safety and soundness of our Regulated Organizations. On 3 November 2020, the European Banking Authority (EBA) published a Discussion Paper (DP) on Environmental, Social and Governance (ESG) risk management and supervision. Some banks have already made significant strategic decisions, ramping up sustainable finance, offering discounts for green lending, and mobilizing new capital for environmental initiatives. As physical and transition risks materialize, corporates will become increasingly vulnerable to value erosion that could undermine their credit status. Climate risk management is the process of assessing, addressing and adaptively managing climate risks that may impact the ability of USAID programs to achieve their objectives. She pointed to the company's three-year Climate Change Action Plan, released in 2018, which "addressed implementation of climate-related governance, risk management… The potential manifestations of climate change and their impacts on economic outcomes. In responding to this growing challenge, central banks around the world, including the Federal Reserve, the European Central Bank, and the Bank of England, are not only examining the implications for monetary policy but are also seeking ways to “bolster banks’ resilience amid economic disruptions caused by extreme weather.”11,12 Reflecting the fact that climate risk is a global challenge and that managing financial risk emanating from climate change will require a global response, leading central banks have also organized a new Network for Greening the Financial System, whose main intent is “to help strengthen the global response required to meet the goals of the Paris agreement, and to enhance the role of the financial system to manage risks and to mobilize capital for green and low-carbon investments.”13, Meanwhile, the Financial Stability Board established the Task Force on Climate-related Financial Disclosures (TCFD), which, in 2017, made recommendations for “disclosing clear, comparable, and consistent information about the risks and opportunities presented by climate change.”14, From the industry side, meeting these TCFD recommendations is no doubt a good first step.15 But many banks are already committed to improving the environment, and are doing quite a bit already to combat climate change, including the reduction of their carbon footprint, financing low-carbon businesses, promoting “Green Bonds,” and being transparent about their environmental practices. The BSP regulations also emphasize the adoption of appropriate credit and operational risk management systems, including stress testing framework. In January 2018, we published a Staff Working Paper on climate change and the macro-economy. Do not delete! has been removed, An Article Titled Climate risk and banking: What more should banks do? In energy, opportunities are present in alternatives, refining, carbon capture, aviation, petrochemicals, and transport. W hile credit portfolio managers generally recognize that physical climate risk needs to be accounted for, questions and misconceptions abound. 1 The final output of the calculations was a counterparty rating that incorporated inputs from physical and transition-risk scorecards. The physical risks of climate change are powerful and pervasive. These require banks to identify, measure, quantify, and monitor exposure to climate risk and 1 Bundesanstalt für Finanzdienstleistungsaufsicht. The best strategy is adequate, comprehensive preparation: a bank can create a value-focused road map setting out an agenda fitted to its circumstances and taking into account both the physical and regulatory status quo. Germany’s BaFin One of the latest blows came from … This will enable the creation of heat maps and detailed reports of specific situations where necessary. To align climate-risk exposure with risk appetite and the business and credit strategy, risk managers should inject climate-risk considerations into all risk-management processes, including capital allocations, loan approvals, portfolio monitoring, and reporting. 18 Ibid. Governance and management of climate-related risks 7 Banking Institution Strategies to face First principle: taking into account its pivotal role, the strategy of institutions, and more specifically its conception by the management bodies, and its implementation within … We then used these factors to generate numbers for depreciation and the probability of default and loss-given default. Estimates are subject to uncertainty about aerosol levels and the urban heat-island effect. As the understanding among financial institutions of the risks and opportunities imposed by climate change becomes more… At the same time, they must ensure that their operations are aligned with the demands of external stakeholders. Site-within-site Navigation. tab. © 2021. ECB launches public consultation on its guide on climate-related and environmental risks. They will need to focus on acquiring them and on developing a strategic understanding of how physical and transition risks may affect their activities in certain locations or industry sectors. Oil and gas, power generation, real estate, automotive, and agriculture present significant green-investment opportunities. Risk management; A sea change – Driving awareness to confront climate risk . 2016). In a competitive environment in which banks are often judged on their green credentials, it makes sense to develop sustainable-finance offerings and to incorporate climate factors into capital allocations, loan approvals, portfolio monitoring, and reporting. An imperative in both cases is excellent climate-risk management. Data will be a significant hurdle. Furthermore, regulation increasingly requires banks to manage climate risk. In preparing for tests, they should first identify important climate hazards and primary risk drivers by industry, an analysis they can use to generate physical and transition-risk scenarios. This box/component contains JavaScript that is needed on this page. 20 percent of the value of listed companies worldwide could be exposed to climate risk. Taking action against systemic bias, racism, and unequal treatment, Key opportunities, trends, and challenges, Go straight to smart with daily updates on your mobile device, See what's happening this week and the impact on your business. 8 Glenn D. Rudebusch, “Climate Change and the Federal Reserve,” FRBSF Economic Letter, Federal Reserve Bank of San Francisco, 2019-09, March 25, 2019. Yellen’s banking agenda: Confront climate risks, launch AML registry By Neil Haggerty January 19, 2021, 3:40 p.m. EST 3 Min Read. The European Banking Authority (EBA) published today its Action plan on sustainable finance outlining its approach and timeline for delivering mandates related to environmental, social and governance (ESG) factors. They should also establish and implement governance frameworks for climate risk—frameworks that include the use of specialized senior personnel, as well as a minimum standard for reporting up and down the business. The strategy complements the asset managers existing World Green Transition Index strategy, launched in 2019. C1.1b (C1.1b) Provide further details on the board’s oversight of climate-related issues. Our mission is to help leaders in multiple sectors develop a deeper understanding of the global economy. Climate Change Risk across the EU Banking System. ... Training your senior management in climate risk. Tailor business and credit strategy. These improvements will cut carbon emissions, capture and store atmospheric carbon, and accelerate the transition away from fossil fuels. 6 Andrew Howard Marc Hassler, “Climate change: Forgotten physical risks,” Schroders, July 2018. As with any risk, financial institutions that fail to effectively manage climate-change risks are more vulnerable to the rising tide of environmental hazards. As the bank developed, tested, and rolled out the methodology, cross-functional teams emerged as a success factor. Subscribed to {PRACTICE_NAME} email alerts. In corporate banking, this kind of measurement and reporting might support a climate-adjusted credit scorecard (covering cash flows, capital, liquidity diversification, and management experience) for individual companies. For further details, see the McKinsey Global Institute report “Climate risk and response: Physical hazards and socioeconomic impacts” (January 2020). In this regard, boards, CEOs, and CROs can play a crucial role in providing leadership on climate risk management by placing climate risk high on the agenda and shaping their institutional responses. Banking regulators around the world, now formalizing new rules for climate-risk management, intend to roll out demanding stress tests in the months ahead (see sidebar “The regulatory agenda”). 1. has followed with similar requirements. Climate Change & the TCFD: Risks & Opportunities for the Banking Industry Course Programme Frequently Asked Questions Tutor’s bio Since 2007, UNEP FI has offered an Online Course on “Climate Change: Risks and Opportunities for the Finance Sector”. Data are needed to understand the fundamentals of climate change as well as the impact it will have on activities such as pricing, credit risk, and client-relationship management. The Action plan explains the EBA’s sequenced approach, starting with key metrics, strategies, risk management and moving towards scenario analysis and evidence for This message will not be visible when page is activated. Some banks have already acted by redefining their goals to align their loan portfolios with the aims of the Paris Agreement. Renewable energy, refurbishing plants, and adaptive technologies all require significant levels of financing. For instance, vulnerability assessments allow businesses to understand where climate change is … Risk Hong Kong 2020. Stakeholders want robust action, and banks feel pressure to respond. Scenario analyses and stress tests, which are high on business and regulatory agendas, will be critical levers in helping banks assess their resilience. 8 September 2020 – UN Environment Programme Finance Initiative (UNEP FI) has released a report on physical climate risks and opportunities from Phase II of its Task Force for Climate-related Financial Disclosures (TCFD) Banking Programme with climate risk … Please email us at: A leading bank incorporates climate risk into its counterparty ratings. Please see www.deloitte.com/about to learn more about our global network of member firms. USAID’s Climate Risk Screening and Management Tools facilitate assessing and addressing climate risks. The EBA sees the need for enhancing the incorporation of ESG risks into institutions’ business strategies and processes and proportionately incorporating them into their internal governance arrangements. Banks expected to integrate climate and environmental risks in business strategy, governance, risk management and disclosure. Third-line oversight, which expands the previous limited role of the internal audit function to assess the impact of climate change on risk … Please click "Accept" to help us improve its usefulness with additional cookies. Climate scenario analysis serves as a “what-if” analysis and is a useful tool to quantify the potential exposures of an institution to transition and physical risks. 3. Global coordination among regulators and the within the banking industry is a must to be truly effective. The surface temperature of the Earth has risen at a record pace in recent decades, creating risks to life, ecosystems, and economies. Integrating climate risk into the broader risk management framework requires an institution to understand and measure its potential exposures to climate change. Clearly, the banking industry needs to address the complex challenges climate risk poses to the world and make climate risk management an independent and robust discipline like credit risk or operational risk. ". and management of these risks require a holistic, strategic, and concerted effort from all central banks, regulators and financial institutions. Northern Trust Asset Management, one of the worlds leading investment managers, continues to expand its sustainability solutions with the launch of a unique, sustainable emerging market green transition index strategy, with climate change considerations as a cornerstone. The counterparty model was useful to differentiate the climate risk among companies within sectors. We strive to provide individuals with disabilities equal access to our website. The commercial imperatives for better climate-risk management are also increasing. 1. In July 2016, we held a joint workshop with the Met Office on climate risk and financial stability. 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