How banks should be looking at the climate change challenge

Mitigating the impact of climate change is not just an environmental responsibility – it is also an economic necessity. 

This is a clear message as global leaders met for the UN Climate Summit this week in New York. The impact of climate change will only intensify over time: rising seas and greater storm surges alone are expected to cost coastal urban areas over $1 trillion each year by 2050.

Governments around the world are making concerted efforts to mitigate the impact. The 2015 Paris Agreement provides the international framework for limiting future warming to no more than two degrees above the pre-industrial average, but achieving this will not be easy: the OECD estimates that $6.9 trillion of investment would be required each year to 2030. 

In 2019, the UK became the first country to commit to a legally binding target to achieve net zero emissions by 2050. In support of this, the UK government published its Green Finance Strategy with the objective of mobilising private capital for sustainable finance, placing the banking sector at the forefront of the UK’s transition to the new climate paradigm.

Bank of England governor Mark Carney has highlighted that the value of virtually every financial asset will be reassessed in a net-zero world. As he warned at the Summit, firms that align to this vision will be rewarded handsomely; those that fail to adapt will cease to exist.

This applies to banks too. As a net-zero world reshuffles the future of industries and infrastructures, the banking sector faces strategic opportunities and solvency challenges, both from climate change itself, and from the mitigation measures associated with it.

Financial regulators have begun placing greater demands on banks to demonstrate effective identification and management of climate risks. Pressure is also being applied to improve how firms report climate risks, with the UK and the EU signalling mandatory disclosure going forward.

Fulfilling regulatory expectations will be no easy task for banks, especially given the uncertainty of how climate-related risks will unfold over time. Indeed, the Bank of England is stress-testing the financial system against climate pathways ranging from the catastrophic business-as-usual to the ideal transition to net-zero by 2050. 

Banks will also require much more sophisticated and nuanced climate risk data than what’s currently available in order to respond effectively.  

And knowing when to act will be challenging too. Much of the financial risks associated with climate change are unlikely to manifest within banks’ typical financial planning cycle of around four years, while the degree to which banks need to seek immediate action depends on the “stickiness” of their balance sheets to climate risks. 

Still, while the range of climate scenarios and solutions may confuse firms and industries, a wait-and-see approach cannot be the path forward. The longer we delay meaningful mitigation, the greater the disruption of climate change will be.

The message from this week is clear: the banking sector will play a critical role in the meaningful transition to a net-zero world – and that starts with putting climate change at the heart of any strategic planning and risk management.

Main image credit: Getty