During RMA’s recent installment of the Risk Readiness Webinar Series,
Chris Lafakis, director, Moody’s Analytics and Gary Way, senior vice president of
Credit Strategy and C&I Portfolio Management, PNC, discussed how to ready
your institution for one of the defining issues of our century.
Climate change presents both physical and transitional risks to the assets
financed by financial institutions. Physical risks include phenomena like
shrinking coastlines and increased risks of crop failure. Transition risks
include the possibility that regulatory or marketplace changes will devalue
things like oil and cars with internal combustion engines.
Lafakis shared Moody’s work in quantifying the critical risks of climate change
and creating scenarios that are consistent with international benchmarks
established by the Intergovernmental Panel on Climate Change (IPCC). Moody’s
assessed six impact channels to determine how they would be affected by
temperature increases. These channels include sea level rise, agricultural
productivity, heat and labor productivity, human health, tourism, and energy
demand. Emerging economies will suffer the most in these scenarios,
particularly Saudi Arabia who will face a GDP 10% lower than it is currently because
of the potential for a decline in oil prices due to a reduction in heating
demand. Winners include countries that will benefit from increased temperatures.
European countries like Denmark, Austria, and Sweden will experience increased
agricultural productivity and rises in tourism due to warmer temps and will not
be affected by a decline in oil prices.
Transitional risks refer to the system-wide costs and sector costs associated
with transitioning to a closer-to-zero carbon world. Sectors impacted include
fossil fuel producers, utility companies, and the transportation industry. Subsequently,
Lafakis and Way recommended that financial institutions exercise caution when
issuing credit to companies that could be affected by transitional risks, for
example, those that leave a large carbon footprint.
Climate change stress testing at banks is challenging because it does not fit
in the current stress testing paradigm, which features a five-year time horizon.
Since the effects of climate change will compound over time, this threshold is
not useful for projections. The U.S. is behind on quantifying climate change
risk and there is no consensus from regulatory agencies on how to address
stress testing. As such, no requirements have been issued for banks in the U.S.
in 2020.
Although climate change risk management is in the initial stages, financial
institutions can find opportunities to position themselves favorably. Lafakis
and Way suggested that institutions become knowledgeable about how different
countries and companies will be affected by the physical and transition risks of
climate change, both the winners and losers, and adjust lending policies and
deployment of capital accordingly.
If
you missed the live webinar, you can purchase a
recording here.
Join
us for the next installment of the Risk Readiness Webinar Series
on December 3, The CRE
Scene.