As digitalisation forces banks to restructure their operations, the technological, political and regulatory shifts brought on by climate change will also drive fundamental business model transformation at banks in the future, according to a report from Moody’s Investors Service.
The 2015 Paris Agreement set a global goal to reach net-zero emissions in the second half of the century, and an increasing number of governments have translated that target into strategy. The EU, Japan and South Korea, along with more than 100 other countries have pledged carbon neutrality by 2050. China says it will do so before 2060.
Countries representing more than 65% of global carbon dioxide emissions have now set out ambitious commitments over the next couple of decades.
“Climate change is driving significant changes to the global economy and the implications for banks are far-reaching,” says Alberto Postigo, a senior credit officer at Moody’s.
Governance and compliance
Multiple areas of a bank’s organisational structure could be affected. A top priority will inevitably be governance, and banks will need to ensure they have the necessary depth of expertise across their organisation, according to the report, published on April 20.
The number of climate-related compliance staff banks employ could soar as environmental regulations become ever more stringent and complex. “Compliance legal costs will increase as banks face more climate standards or regulations and banks may require new departments or employees with different skill sets,” Mr Postigo says.
Climate change is driving significant changes to the global economy and the implications for banks are far-reaching
Risk management could be another growth area and climate risk will need to be incorporated into the risk management frameworks to ensure it is appropriately identified, measured and accounted for, Mr Postigo adds. “Banks’ reporting units will be affected in terms of internal reporting for risk management purposes. Banks will also have to improve public disclosures of climate-related risk.
“Regulatory or fiscal incentives to promote climate policies could also distort banks’ risk measurement, so there will be a clear new source of underwriting risk for banks,” Mr Postigo says. While climate risks are difficult to model, Moody’s expects banks to gradually become better at managing and pricing them.
“Reputational risks will be high because banks are under scrutiny from a broad set of stakeholders. This is particularly true for large banks, many of which have committed to ambitious targets for net-zero finance. There is potential reputational damage for banks if they fail to meet these targets.”
Revamped asset portfolios
Banks’ asset portfolios also stand to change significantly as economic models transition to low levels of carbon emissions. Many industries face pressure to transform, while others become redundant.
Across the world, investment in climate-friendly assets such as renewables and energy-efficient real estate is expected to play an increasingly prominent role. The rapid expansion of banks’ low-carbon asset portfolios, however, could increase exposure to assets with unproven economic viability.
“Many large banks are already making changes and moving faster than their smaller and medium-sized peers. But larger banks also face greater pressure from a range of stakeholders to lead by example,” Mr Postigo says, adding that lenders that are slow to adapt could face pressure on their credit strength.
The report highlights how green loan growth has been accelerating in China on the back of new regulations in support of the country’s strategy of reducing carbon dioxide emissions from 2030, and achieving carbon neutrality by 2060. According to the People’s Bank of China, the balance of green loans to clean-energy industries surpassed the balance of loans to energy-intensive industries – such as coal, iron and steel – at the end of 2020.
