The big ball of the banks on climate change
Climate risk management: some British, Dutch and Swiss banks stand out positively. Nordic, French, Spanish and Japanese banks are lagging slightly, while Irish, German, Italian and Chinese banks are lagging behind. The analysis by Paul Smillie, senior credit analyst, and Rosalie Pinkney, senior credit analyst and Natalia Luna, senior thematic investment analyst at Columbia Threadneedle Investments
For investors evaluating financial institutions, the climate crisis will soon become a key consideration. Our research shows that there is already a wide dispersion between industry leaders and laggards.
In his landmark 2015 speech, Mark Carney, then Governor of the Bank of England, invoked the specter of a "Minsky moment," a collapse in asset prices caused by the climate crisis. At the time, his words sounded dystopian and seemed to evoke a distant perspective. Today, however, they appear more prescient.
A large number of central banks fear that climate change could trigger the next financial crisis. For this reason, supervisors in Europe and the UK are already beginning to examine the resilience of banks to climate change, assessing both the likely tensions arising from the transition to a zero-carbon economy in the coming decades, and the impact of extreme weather conditions.
For the moment, however, the anxiety of the monetary authorities is not reflected in the equity or bond markets, which seem relatively little affected by climate risk. Yet in the coming years, climate change could become a key driver of financial performance and an important factor for investors evaluating banks.
There is no shortage of risks to earnings in the short term either, while in the medium term, institutions with higher climate-related exposures are likely to face higher capital requirements, not to mention reputational risks. But it's not just a question of risk. Looking ahead a few years, there may also be opportunities for banks to guide the financing of the transition to a zero-carbon economy. In fact, it is estimated that green investments and financing could raise up to $ 50 billion in revenues over the next 5-10 years.
MOTORS OF CHANGE
As climate change is set to become a major issue, we believe that it will soon no longer be enough for banks to make general climate commitments. Under increasing scrutiny, banking institutions will need to improve climate risk reporting, demonstrate that climate considerations fit into underwriting standards, and reduce their carbon footprints.
Although banks 'exposure to fossil fuels is relatively modest – carbon-intensive sectors currently account for less than 10% of European institutions' credit exposure – a climate crisis could escalate according to calculations by the European Central Bank (ECB). losses of the banking system up to 60%, with significant repercussions on profits, given that fossil fuels represent 10% -15% of the revenues generated globally by wholesale banking. Reputational risk is already on the rise.
Consider the criticisms leveled at JP Morgan Chase in 2020 for its loans to the energy sector. In a report compiled by a collaboration of non-governmental organizations (NGOs), including Rainforest Action Network and BankTrack, the US bank was found to be the largest fossil fuel lender globally. Given the growing public awareness of climate change, possible reputational damage should not be ignored.
Banking supervisors are beginning to enforce a number of changes, especially in the EU and the UK. French and Dutch central banks performed climate stress tests in 2020, the Bank of England did it in 2021, and the ECB plans to do so in 2022.
Looking to 2025, the European Banking Authority (EBA) intends to introduce a review of the ESG capital requirements, which will differentiate the capital treatment of assets based on environmental and social factors. In the UK, banks will need to comply with the Task-Force for Climate-Related Financial Disclosures standards by 2025, providing standardized information on their climate risks.
In the United States too, of course, a tightening of regulation is just around the corner. In November 2020, the Federal Reserve identified climate change as a risk to financial stability for the first time. Additionally, President Biden said he considers climate change a priority and plans to require listed companies to disclose information on climate-related financial risks.
LEADERS AND LAYERS
So far, however, there is little indication that banks are cutting back on fossil fuel-related loans, with the notable exception of coal. However, investors may soon begin to distinguish between leaders and laggards, thanks to better data extracted from mandatory disclosures. In addition, shareholder engagement and NGO activism could quickly impact on bank equity valuations.
We conducted an engagement exercise with more than 50 banks globally, asking questions about climate strategy and climate risk management and following up with a series of meetings. We have thus seen the emergence of some clear trends.
Generally speaking, some British, Dutch and Swiss banks stand out positively. Nordic, French, Spanish and Japanese banks are lagging slightly, while Irish, German, Italian and Chinese banks are lagging behind.
We have begun to take into account the exposure of banks to climate risks in our research. Climate change is not yet impacting banks' earnings or capital requirements, but it could as early as two or five years from now.
As we take a two-year forward horizon in our business valuation, we incorporate this dimension into our bond research and assign the relevant ratings to banks. These valuations are beginning to influence the construction of the portfolio. In our view, it won't be long before investors begin to distinguish between leaders and laggards. This will create an opportunity for active investors, while rewarding banks that have acted promptly to tackle climate change with a competitive cost of capital.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/cambiamento-climatico-banche/ on Sat, 16 Oct 2021 05:13:38 +0000.