At Great River Energy’s Coal Creek Station, North Dakota, steam is exhausted through exhaust systems. Some of the largest banks in the US have cut lending to the coal sector in recent years, but they still have a lot more to do to reduce climate risk on their loan portfolios, a new report says.
Daniel Acker | Bloomberg | Getty Images
The financial world is beginning to reckon with a hard truth: Climate change poses a clear threat to the entire US financial system.
With forest fires on the west coast, hurricanes in the south, and a megadrought in the west, investors, lawmakers, ex-regulators, and advocates are setting alarm bells off for U.S. financial regulators and the banks they face about the danger our markets face if they fail to act around themselves to protect against this risk.
Some of the largest investors in the country this summer sent public letters to the heads of financial regulators calling on them to take on the mantle of climate change as a systemic financial risk. California controller Betty Yee wrote a comment Urging “Lead all US financial regulators to move to a resilient, sustainable, low-carbon economy and avoid climate-induced financial collapse”.
Senate and House Democrats published reports Detailing the risks and calling for stronger measures to reduce them. In September even a subcommittee of the Commodity Futures Trading Commission issued its own reportand advises his own agency and many others to step up and lead the climate to avert a potential crisis.
A fresh look under the hood of US banks makes the extent of this risk much easier.
The US banking sector is far more vulnerable to the effects of climate change than banks, according to new research. This vulnerability should not only affect large investors and regulators, but anyone with savings in a bank or money invested in a pension fund.
This study found that, in addition to the losses due to the physical effects of climate change, any major US bank has the potential for dramatic losses if the companies they borrow do not plan to transition from fossil fuels. These results come from an assessment of not only U.S. banks’ fossil fuel lending, but their broader loan portfolios as well – including the risks an unplanned transition from fossil fuels to assets would have in the sectors that rely on those industries most, such as agriculture, manufacturing and transportation.
In its new report “Financing a Net Zero Economy: Measuring and Managing Climate Risk for Banks, Ceres sees a significant risk for climate risk in the syndicated loan portfolios of the largest banks.
Given this broader view of climate risk, the risk is so significant that it could spark a financial crisis, as more than half of the syndicated loans from all major US banks are exposed to significant climate risk, which translates into more than $ 100 billion could translate into losses. In addition, this number only reflects part of their balance sheet and assesses only one type of climate risk. If the full balance sheet were publicly available, the potential losses would likely be even greater.
What can a bank or supervisory authority do?
US regulators can do what capital market leaders ask them to do – regulate climate change as a systemic financial risk. This includes the obligation to disclose climate risks from the sectors they monitor and the requirement that financial institutions include climate risk in their scenario analysis and in their stress tests. Central banks in Europe, Canada, Japan and New Zealand are already doing this. It’s time for US regulators to do the same.
We are beginning to see US regulators start to act. California Insurance Commissioner Ricardo Lara has created a public database of environmentally friendly insurance products. New York Treasury Superintendent Linda Lacewell told insurance companies that they need to incorporate climate risk into their scenario analysis. Regional Fed offices, particularly in San Francisco, Richmond and New York, are taking steps to better understand the systemic risk of climate change.
That movement will grow as climate change worsens, and the financial implications of inaction will become clearer.
But banks can’t just wait for regulation to come. They must proactively assess their full exposure to climate risks and disclose what benefits them regardless of new laws or regulations. The current focus is on syndicated loans from banks as these are publicly available. In order for banks, their investors, their customers and their regulators to better understand the sector’s vulnerability to climate change, banks need to quantify climate risk at both corporate and portfolio level across all asset classes and business areas.
Banks that are already measuring their vulnerability to climate change should dive deeper and use their lending power to ensure that those who borrow them disclose their emissions and make their plans to do business in a world with limited carbon emissions. We started with banks moving away from coal financing. We need to see them doing this type of exposure on their loan portfolios. If that commitment doesn’t lead to action, they should be ready to walk away.
Finally, banks should take steps to reduce their climate risk through direct customer loyalty and to commit to aligning their customer portfolios with the goals of the Paris Agreement. These commitments should include detailed interim targets and specific deadlines for sectoral portfolios to achieve net zero emissions by or before 2050. We have seen encouraging progress lately in commitments from major US banks such as Morgan Stanley and JPMorgan Chase. However, these and other companies still have more work to do to achieve the required level of specificity and ambition.
Banks and regulators have cut their jobs out for them, as have the investors and customers who rely on them, but the longer they wait, the harder and more expensive the work becomes. Banks’ vulnerability to climate change will continue to grow regardless of the US presidential election result. In order to avoid another crisis at the systemic level, as experienced the world in 2008-2009, only concerted systemic prevention measures are sufficient.
– By Steven M. Rothstein, Managing Director of the Ceres Accelerator for Sustainable Capital Markets, and Dan Saccardi, Senior Director of the Corporate Network at Ceres. Ceres recently published the report Financing a Net Zero Economy: Measuring and Managing Climate Risk for Banks.