Increasingly we hear more and more about the need to consider the risks and associated costs of climate change in our economy. Many industries are being proactive in looking how they are able to mitigate those risks and disclose this to investors and consumers.
Banks – while there are some exceptions and good examples to follow – are lagging other sectors by not integrating climate change risk into their long-term strategic planning, or demonstrating they understand the implications of this game-changing phenomenon for their business operations. Investors may unwittingly invest in financial institutions that will be adversely impacted by the effects of climate change.
The risk to banks is especially high. Here’s why: banks are connected to every market sector, making them uniquely vulnerable to the economic and political uncertainty caused by climate change. Since banks are not required to disclose climate risks, investors simply cannot see the potential risks buried in their portfolios. So investors’ “green” portfolios may not be so green.
Investors should be concerned about potential long-term, climate-related risks, including: inaccurate risk assessments, unanticipated project costs, changing regulatory environments, legal and reputational risks, uncertain demand for high-carbon fuels, banker incentive misalignment, and unpredictable, extreme weather patterns.
In a recent report Financing Climate Change: Carbon Risk in the Banking Sector Boston Common Asset Management calls on investors to push for systemic change in the banking industry to address climate change risks.
In conjunction with the publication of this report, Boston Common is organizing a global investor coalition to engage in conversation with 50 banks that are the largest underwriters to carbon intensive industries.
The coalition will invite banks to develop a long term climate strategy, help investors make informed decisions with more robust climate related disclosures and to support the positive role banks they should play in financing a more sustainable climate future.Specifically banks are asked to reassess climate risks and to vet opportunities through the three action steps.
First, banks need to recalibrate risk management to integrate climate change. Climate risk is one of many risks that banks face and it should be integrated into the risk management committee deliberations and compliance practices. Specifically, banks should:
- conduct regular stress tests that model the effects of adverse climate events
- rebalance portfolios in view of potential risks from climate change;
- consider the legal and reputational implications of investments; and
- reassess loan pricing with an eye to possible shifts in demand for high carbon fuels, and other climate-related changes in consumer behavior.
Second, banks should drive financial innovation. Banks should seek opportunities to finance, underwrite, insure, and invest in new products and services. Business opportunities include increasing energy efficiency, producing more renewable energy, and developing adaptive responses to climate change.
Third, banks should develop a long-term climate strategy. And investors need to understand both a bank’s overall environmental vision and the strategy for its implementation. Banks must move beyond anecdotes about individual funded projects and instead provide company-wide assessments of the implications of climate change.
Specifically banks should:
- Measure and disclose total carbon footprint
- Align banker compensation with longer-term goals
- Incorporate climate change considerations into board oversight mandates
Investors and consumers can play a role too. They must better assess the embedded climate risks in their financial holdings and support the critical role that banks can play in transitioning to a low carbon economy.
They can start locally by asking their own banks to explain their climate policies, and by calling on the banks in their investment portfolios to do the same.The banking sector is behemoth and if it takes aggressive action, it can significantly reduce investor risk—and negative impact to the environment.
Lauren Compere is Managing Director at Boston Common Asset Management