Northampton, MA – News Direct – Ceres
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By Dan Saccardi, Program Director, Ceres Company Network; Blair Bateson, Director, Ceres Corporate Network; and Tamar Aharoni, Senior Associate, Ceres Company Network
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As the lynchpin of the global economy, financial institutions not only have a responsibility to help mitigate climate change, they are also vulnerable to its financial risks. The SEC recently recognized this in its proposed rule requiring financial institutions to report climate risks in financial terms.
It is clear that climate risks are systemic risks for banks. Over the past two years, Ceres has published reports quantifying the impact of two main risks on banks – the risk faced by the companies in their portfolios by a delay in the transition to a clean economy and the physical risks of a warming one planets these companies are exposed to. Our analysis of 2021 climate change physical risks, from extreme storms to droughts, estimates that banks’ climate value-at-risk on their syndicated loans could exceed $250 billion annually by 2080.
For banks, quantifying these risks is a crucial step in managing the climate risks in their portfolios. The top-down analysis we’ve performed in our reports covers a specific subset of the largest US banks’ portfolios – syndicated loans – and allows us to provide a framework for the kind of comprehensive analysis needed to understand the risks released by climate change.
But this top-down analysis is akin to quantifying just the tip of the iceberg. The “unseen” part of physical climate risk is still sunk in deep waters – particularly the assets of the customers who finance banks. Understanding this part of climate risk requires a different type of analysis – bottom-up analysis using data only the banks have. Banks need to analyze the risk of the customers they finance at the asset level in order to adequately show the extent of the physical risks that financial institutions are exposed to from climate change.
The story goes on
In last year’s Physical Risks report, we explored how this bottom-up analysis of asset-level data might be performed, but we did not have the data to fully perform such an analysis. Building on this work, we and climate analysis firm FutureProof have developed an approach that uses one of the few publicly available asset-level datasets: banks’ physical offices and branches.
Of course, the most significant physical climate risks that banks face come from a more indirect source: the customers they finance and the physical risks those businesses face. However, because this type of customer data is not publicly available, we modeled the banks’ own physical offices and branches as an example of the type of customer-centric asset-level analysis that banks need to perform. By applying this type of asset-level assessment to their customers’ physical risk, banks could respond to these risks by anticipating the magnitude of losses, pursuing ways to minimize them and investing in climate resilience actions to benefit their bottom line and affected communities get .
A prototype for bottom-up analysis
Analyzing a sample of over 20,0001 banks, we projected climate-related financial losses—as defined by the SEC’s proposed requirements—at banks’ facilities this century from perils such as floods, hurricanes, wildfires, tornadoes, hail, snowstorms, and winds, and Lightning. For flood damage specifically, our forecasts in this report are based in part on combining flood maps, flood event sets (including climate-altered event sets) and software from modeling company KatRisk with FutureProof’s proprietary methods to convert this into financial losses.
Figure 1 illustrates this analysis. This analysis is, at least qualitatively, a proxy for physical climate risk for banks’ broader portfolios. In the absence of better data, it is reasonable to assume that the geographic concentration of banks’ facilities is consistent with that of their broader portfolios.
Our analysis used two different models of climate scenarios set out in the Intergovernmental Panel on Climate Change (IPCC) AR5 reports that imply specific levels of carbon emissions and temperature rise. Even considering the less disruptive scenario (RCP 4.5, see Caption 1), the projected average losses increase significantly over the remainder of the 21st century, from 0.23% of the asset in 2021 to 0.31% by 2050 and 0.46% . in 2099. For example, if a bank has a $100 million facility, that means it will suffer an average of $460,000 in annual losses through 2099 due to climate-related factors. This would rise to $550,000 (0.5%) in the worst-case scenario (RCP 8.5).
Who is most at risk?
Such losses can vary by bank type, which we examined using two dimensions: industry segment and size (revenue tertile).
Figure 2 shows that despite varying impacts, no industry segment is spared significant losses. Looking at size, the analysis shows that higher-revenue banks tend to have lower climate-related losses. One possible explanation is that these banks are able to locate their facilities in areas with more climate-resilient measures. Another possible cause is simply the fact that larger banks are more geographically diversified.
A Tale of Two Banks
To put the data into context, we profiled two actual banks (although their identities have been kept anonymous): Bank A, which is mostly based in the San Francisco Bay Area, and Bank B, which is mostly based in the New York area City is based. We have chosen to compare these two banks based on their geographic concentration – such concentration means that the risk to their facilities may more closely reflect the more material risks posed by the physical risk of their customers.
Bank A’s losses in the Bay Area stem primarily from exposure to flooding and wildfires. Bank B’s NYC branches, on the other hand, lost mainly due to flood and hurricane risk. Both banks are exposed to relatively low levels of climate risk compared to our overall sample average, although our analysis also revealed that certain industries are exposed to significant and increasing climate risk.
What should banks do next?
As a proxy for physical climate risk for banks’ broader portfolios, our analysis of banks’ facilities can be viewed as a lower bound on the losses banks will incur from physical climate change (since we only used data on banks’ own facilities and not those of their customers). This gap underscores the importance of banks conducting a comprehensive assessment of physical climate risk at the asset level. Unfortunately, such data is currently limited. As a first step, banks and insurers would have to implement a process to collect the relevant data from their customers as part of the lending process. This information is critical to evaluating individual customer relationships and potential transactions. Banks need to address this challenge to fully understand and prepare for their exposure to future climate events that are becoming increasingly frequent and severe. The Securities and Exchange Commission’s (SEC) proposed rule requiring mandatory disclosures on corporate climate is an important signal that the market is moving towards regulating corporate disclosures. However, far more detailed data is required to perform this asset-level analysis, so banks cannot simply rely on the SEC.
The projected losses in our analysis – and what they imply in terms of larger risks for banks – are not inevitable. They can be reduced as banks become more climate resilient. Adaptation is a critical and often neglected way to reduce exposure. Managing climate risks at the asset level should be viewed as a potential opportunity for banks to create significant new value for their institutions, their customers and the economy at large.
Check out additional multimedia and more ESG storytelling from Ceres at 3blmedia.com
View the source version on newsdirect.com: https://newsdirect.com/news/financing-a-net-zero-economy-banks-must-grapple-with-asset-level-data-130494082
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