The planet is warming at an alarmingly rapid rate, and unless swift action is taken to curb the emission of greenhouse gases, the economic costs will be severe.
In the United States alone, extreme weather events triggered by climate change are already causing an estimated $240 billion in economic damage a year, and that figure is expected to climb to well above $300 billion over the next decade as the atmosphere continues to warm and hurricanes, droughts and wildfires intensify.
All this matters to banks, because their portfolios are chock full of loans to industries — think agriculture, tourism, real estate and energy — that could be particularly hard hit by warming temperatures.
It’s not hard to imagine, for example, persistent droughts wiping out corn and soybean crops and forcing ski resorts to shorten their seasons. Intensifying hurricanes could cause severe property damage in major coastal cities and knock out offshore oil rigs, while wildfires in the Western U.S. not only threaten timber and wine production, they could worsen air quality, threatening people’s health and productivity. Eventually, rising sea levels could swamp picturesque beach towns, decimating tourism and real estate values.
The risks are real enough that some large global banks — though not enough of them, in the view of some investors — are now doing what’s called “scenario analysis” in an attempt to get a better grip on how warming temperatures might impact their loan and investment portfolios in the short term and long term.
Call it stress-testing for climate change.
France’s Credit Agricole is on the leading edge of this practice. Using methodology developed by two French academics, the bank in 2017 undertook a broad review of its loan and investment books, industry by industry and country by country, to understand the full extent of its carbon exposure under various warming scenarios. It also identified which of its corporate customers might be hurt most by a global transition to more renewable energy, and presented the results to its business and geography heads throughout Europe and Asia.
Jerome Courcier, the chief corporate social responsibility officer at Credit Agricole, said that the goal of the exercise was not to mandate that its business heads stop financing activities that use or produce fossil fuels, but rather to “enhance transition” to greener solutions.
“There are a few no-nos” — Credit Agricole will not financecoal-fired power plants or Arctic oil drilling, for example — “but the general idea is not to exclude, but to follow the trends and try to accelerate pace of transition of your customers,” Courcier said. “And if you feel like your customers don’t care, then maybe you go find new customers.”
Scenario analysis has been identified as a best practice by the Task Force for Climate-related Financial Disclosures, a group formed in 2015 by the Financial Stability Board and chaired by Michael Bloomberg that encourages global companies to voluntarily disclose their climate-related risk to investors, insurers, regulators and other stakeholders.
It also has been embraced by the United Nations Environment Program Finance Initiative, which earlier this year brought 16 global banks together to participate in a program where the banks stress-tested their loan portfolios under various warming scenarios over the next 10, 20 and 30 years. Participants included BNP Paribas, Barclays, Royal Bank of Canada, TD Bank Group and Citigroup.
Sonia Hierzig, the senior projects manager for climate change at ShareAction, a London-based nonprofit that advocates for responsible investing by financial firms, said that major banks are coming under increasing pressure from socially responsible investors to perform scenario analysis.
Investors like Boston Common Asset Management want to know where the trouble spots might be in their portfolios and how much the banks themselves might be contributing to global warming through their own financing activities. (A recent
At the same time, scenario analysis can help banks identify opportunities in financing large-scale green energy projects, she said.
“If we are to meet climate goals, there is so much money” — as much as $26 trillion by 2030, according to some projections — “that will go into the transition to low-carbon economy,” Hierzig said.
“Banks will need to play a really big role in providing the capital that is needed.”
A recent
For the planet to avoid that fate, human-caused carbon dioxide emissions would need to fall 45% below 2010 levels over the next decade and net emissions would need to equal zero by 2050. Those targets may or may not be realistic, but getting anywhere close to them will require large-scale changes in everything from building design to transportation to shipping to city planning.
For banks, one big challenge with scenario analysis is developing the right methodology that will allow them, and their investors, to draw meaningful conclusions from the results. Bankers who participated in the pilot program used various methodologies — some proprietary, some publicly available — that even they acknowledge are far from precise.
Another challenge is determining what to analyze in the first place. Lauren Compere, a managing director at Boston Common Asset Management, said that if there’s one criticism of the way banks are going about stress testing it’s that their analysis is not robust enough. In the U.N. pilot program, for example, participating banks only performed scenario analysis on small slices of their loan and investment portfolios.
“I think banks are appropriately prioritizing their highest-risk sectors, but they are cherry-picking and not looking at the impact [of climate change] across their entire loan portfolio. That concerns us,” said Compere, whose firm holds investments in a number of large global banking companies, including JPMorgan Chase and TD Bank.
Nicole Vadori, the head of environment at TD, is urging investors to be patient. The climate and weather models banks are using, she said, can produce a range of results and will take time to be refined to the point where banks are comfortable sharing the information with investors. Collecting accurate information from banks’ scores of clients across an array of industries can also be difficult.
“Data challenges are huge right now,” Vadori said. “For a bank to do a climate analysis is much more onerous than, say, for a gas and oil company doing an assessment. We have different kinds of clients: power and utilities, real estate, gas and oil, mining. Plus we have to look at different parts” of TD’s business, “including insurance, lending and investment. All those have different implications, so a very big investment is going to take lots of time.”
Still, TD appears to be taking scenario analysis seriously, which is more than can be said for many other large banks in North America.
According to a survey conducted by Boston Common Asset Management in 2018, European banks are far ahead of large banks in the U.S. and Canada in implementing climate-related risk assessments. Specifically, 80% of European banks surveyed are, in some way, stress-testing their loan and investment portfolios for a 2-degree-Celsius increase in global temperatures, versus just 44% of banks in North America.
Boston Common’s Compere said that while she is encouraged by steps individual banks are taking to curtail financing of fossil fuel exploration, she has been discouraged by the general reluctance of U.S. banks to do the rigorous analysis needed to guide future decision-making.
“The U.S. banks are not really at the table,” said Compere, noting that some industry leaders she has met with didn’t even know what scenario analysis was. “There’s just not enough leadership on this issue from the bank trade associations or the banks themselves.”
Nathan DiCamillo contributed to this story.
