INTEGRATING CLIMATE RISK INTO THE BANK’S RISK MANAGEMENT STRATEGY
Climate risks have become a major concern in the field of finance. Due to climate change and its potential impact on the economy, banks must now take these risks into account in their risk management. In this blog, we will explore the importance of integrating climate risks into banks’ risk management, and the steps they can take to address this new reality.
II. Climate risk categories and challenges
1. Categories of Climate risks
There are a multitude of risks impacting the banking business, all closely related to climate change and the need to make the transition to a green economy:
- Physical risks:
Climate-related physical risks include extreme weather events such as storms, floods, droughts and forest fires. These events can damage infrastructure, real estate, crops and supply chains, resulting in significant financial losses. For example, a bank that has granted mortgages on real estate at risk of flooding may suffer losses if the property is damaged or destroyed.
- Transition risks:
Transition risks relate to regulatory, political, technological and economic changes aimed at reducing greenhouse gas emissions and promoting a more low-carbon economy. These changes can have a significant impact on certain industries, creating financial risks for financial institutions that are exposed to these sectors. For example, a bank that has granted loans to companies heavily dependent on fossil fuels may face losses if these companies are exposed to stricter regulations or a drop in demand stimulated by the anti-climate pollution behavior of eco-consumers.
- Liability and reputation risks:
Liability risks are associated with potential legal actions and claims related to the impacts of climate change. Stakeholders, including investors, customers and local communities, may hold financial institutions accountable for activities that contribute to climate change, or that fail to take sufficient account of climate risks. Such claims can result in high legal costs, fines and reputational damage.
Because of these risks, financial institutions, including banks, need to integrate climate considerations into their policies, risk management practices and investment decisions. This enables them to better assess and manage climate-related risks, protect their assets and financial interests, and contribute to a transition towards a more sustainable and climate-resilient economy.
The integration of climate risks into a bank’s risk management has become an inescapable necessity, in view of the increasingly serious impacts on its development.
If a FI neglects or disregards the risks associated with climate change, it will suffer direct repercussions on several aspects of its business, in particular
- The value of guarantees:
By integrating climate risks into risk management, FIs can better identify, assess and mitigate the impact of extreme weather events such as storms and floods on commercial mortgages and infrastructure investments.
By remaining alert to the effects of the transition to a low-carbon economy, FIs will avoid the depreciation in value of assets linked to investments in fossil fuels.
Customers, investors and other stakeholders are increasingly attaching importance to the social and environmental responsibility of financial institutions. Banks that integrate climate risks into their risk management demonstrate their commitment to sustainability and responsible resource management. This can boost customer and investor confidence, protect the bank’s reputation and give it a competitive edge.
- Innovation and growth opportunities:
By neglecting climate risks in their risk management, banks can be deprived of new business opportunities, such as financing renewable energy, energy efficiency and sustainable infrastructure projects. This can open up new markets and stimulate long-term growth.
- Compliance with local and international regulations and requirements:
Financial regulators around the world have begun to take steps to integrate climate risks into the risk management of financial institutions. They are demanding greater transparency and disclosure of the climate risks to which banks are exposed. Non-compliance with these requirements exposes FIs to multi-faceted sanctions.
Indeed, global regulations and initiatives aimed at encouraging the integration of climate risks continue to multiply and diversify:
- Recommendations from the Task Force on Climate-related Financial Disclosures (TCFD):
The TCFD, set up by the Financial Stability Board (FSB), published recommendations in 2017 to help companies disclose climate-related risks transparently. These recommendations encourage financial institutions to assess climate risks, integrate them into their risk management and disclose them systematically. TCFD recommendations include the disclosure of transition scenarios and climate sensitivity analyses.
- EU Sustainability Disclosure Directive:
The European Union has adopted a Sustainability Reporting Directive (SRD), which requires financial institutions to disclose information on how they integrate climate risks into their activities. The SFDR aims to increase the transparency and comparability of sustainability information for investors and customers, with the directive coming into force on March 10, 2021.
- Bank for International Settlements (BIS) guidelines:
The BIS has published guidelines to help banks integrate climate risks into their risk management. These guidelines focus on the assessment of physical and transition risks, the integration of climate risks into risk management frameworks, governance and disclosure. The BIS also encourages banks to work with other stakeholders to develop common standards and practices for climate risk management
- United Nations Environment Program Finance Initiative (UNEP FI) standards:
UNEP FI has developed several standards and tools to help financial institutions integrate climate risks into their risk management. For example, the “Principles for Responsible Banking” establishes the fundamental principles for the responsible management of environmental and social risks, including climate risks. In addition, UNEP FI has developed tools for assessing and managing climate risks, such as the Portfolio Climate Risk Assessment Tool.
In short, integrating climate risks into a bank’s / FI’s risk management is essential to protect financial interests, comply with regulations, manage reputation and seize growth opportunities in a changing climate. Banks need to assess and mitigate climate risks to ensure their resilience.
III. Update on climate risk mangement by banks
1. At world level
Several banks around the world have taken concrete steps to integrate climate risks and implement adaptation and mitigation measures. Here are a few examples of banks that are recognized for their initiatives in this area:
Citigroup: Citigroup has announced its commitment to mobilize $1,000 billion by 2030 to finance climate and sustainability initiatives. The bank aims to support projects such as renewable energies, energy efficiency and the transition to a low-carbon economy. On the subject of transparency, Citi has been reporting its greenhouse gas emissions for almost twenty years, and in 2018 was the first major
JPMorgan Chase: JPMorgan Chase has committed to aligning its financing activities with the objectives of the Paris Agreement. The bank has announced that it will no longer finance coal-fired power plant development projects and will strive to achieve a net zero carbon footprint by 2050.S b
Banco Santander: Banco Santander has implemented a sustainable financing strategy that includes green loans and green bonds. It aims to be a responsible bank and has set itself several targets, including the provision of EUR 220 billion in green financing between 2019 and 2030. In the first half of 2023, Banco Santander managed a total of EUR 1,250 billion in deposits, served 164 million customers, had 9,000 branches and 212,000 employees, and is committed to reducing its carbon footprint by 90% by 2025.ank to publish its first climate report following the TCFD’s recommendations.
ING Group: ING Group has developed a climate risk management approach by assessing the exposure of its portfolio to climate risks and identifying the most vulnerable companies. The bank also integrates ESG criteria into its investment decisions and has set up initiatives to finance clean energy projects.
Standard Chartered: In early 2020, Standard Chartered Bank announced that it would devote $75 billion by 2024 to supporting its customers in the transition to a low-carbon economy. The bank has also launched an initiative to support the transition to a low-carbon economy in Asia and is working to reduce its carbon footprint.
Bank of America :In 2021, the bank is making the transition to a sustainable economy. It has announced the deployment of $1,000 billion by 2030 as part of its Environmental Business Initiative, to green the economy and achieve its initial goal of zero net greenhouse gas (GHG) emissions by 2050.
Goldman Sachs has announced since 2019 that it intends to invest $750 billion in the fight against global warming over the next decade. It is thus committed to accompanying its customers in the march towards sustainability by financing sustainable development projects that fall within the framework of the climate transition and promote inclusive growth for disadvantaged people.
These examples illustrate the diversity of measures taken by banks to mitigate climate risks. They also demonstrate the growing importance attached by the financial sector to addressing climate issues and promoting sustainable development.
2. At Africa level
A 2021 EIB survey of 78 major African banks and finance institutions reveals that African banks are increasingly aware of the need to address the risks posed by climate disruption, and are beginning to take advantage of the opportunities offered by green finance.
The survey reveals that of the banks surveyed, 54% already consider climate as a strategic issue, and just over 40% have staff working on climate-related perspectives. Other financial institutions, notably in the microfinance, private equity and insurance sectors, are also filling the gaps in the green finance market.
However, the major concern for African banks and authorities remains that of raising adequate resources in terms of cost and duration. In this respect, according to the African Development Bank report, North Africa will require around $280 billion between 2020 and 2030 to support its transition to a low-carbon, climate-resilient economy. Tunisia receives around 48.3% of the annual climate funding it requires, putting it at the top of the North African region, followed by Egypt with 35.8%. However, there are significant disparities between countries, with Mauritania receiving just 2.2% of its required climate funding.
3. In Tunisia
In its report on the African Economic Outlook 2023, the AfDB states that Tunisia will need to mobilize $24.4 billion over the period 2020-2030 to respond “adequately” to the challenges of climate change,
It explains that adaptation and mitigation costs are estimated at $4.22 billion and $14.39 billion respectively, while losses and damages caused by climate change are estimated at $4.99 billion.
The AfDB recommends that Tunis turn to the private sector and financial markets (green bonds and the carbon market) to mobilize the necessary funding.
Nevertheless, the facts show that Tunisia has done a great deal of work on mitigation through the implementation of energy efficiency programs, but much remains to be done on adaptation and the development of renewable energies.
As far as the role of the financial sector is concerned, and over and above financial constraints, Tunisian banks are called upon to grasp the concepts and issues involved in climate finance, to be familiar with the main dedicated funds (including the Green Climate Fund), and to master the structuring of projects and procedures for accessing climate financing.
The positioning of banks, especially medium-sized ones, with regard to climate risks remains an issue that cannot be mastered by them alone. Indeed, the specific characteristics of investments in green projects and the implementation of the solutions advocated to ensure the climate transition necessarily call for a contribution from regulatory authorities and governments to help banks assume their roles in managing the inherent risks.
In particular, we are calling for greater flexibility in regulations and policies aimed at reducing greenhouse gas emissions and promoting a low-carbon economy (subsidies, provisioning, etc.). We are also calling for advantageous and incentivizing weightings of the risks associated with green loans granted by banks in the structure of various regulatory ratios (solvency ratios in particular).