Climate Risk Management for Banks: A Complete Guide

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Climate change poses vital risks to the financial systems and the economy.

The combined financial and economic outcome related to climate change may lead to considerable future losses for banking institutions. With the advancement of the digital world, banks need ways to better understand, predict, and mitigate climate risks.

What are the risks being faced by banks?

Daily, financial institutions, specifically banks, are heavily exposed to various and complex risks. That includes credit risk, market risk, strategic risk, ALM risk, liquidity risk, funding risk, reputational risk, and legal risk. Climate change and banks are in addition, Environmental, social, and governance (ESG) issues. As well as their associated opportunities and risks, they are becoming more and more relevant for financial institutions.

For banks, sustainability is not just an ethical question, but will soon enough also become an economic question.

Increase in demand of investors for sustainable products as well as growing pressure from regulatory bodies intensifies the need for banks to consider ESG risks in their risk management framework. Bank regulators and their stakeholders are now building a capacity to understand how climate change affects the economy. In the eyes of financial regulators, physical risk and transition risk can be defined as:

  • Physical Risk –  These are climate change challenges for central banks and financial regulators. These risks arise from environmental factors that could affect the premises and operations of a bank. They include extreme weather events and long-term shifts in climate leading to the closing of retail branches or facilities, negatively impacting the creditworthiness of clients, and adversely affecting asset prices.
  •  Transition Risk – A shift in operating model as global commerce transitions to a lower carbon economy. They include the extent to which a bank funds or has stakes in companies that emit greenhouse gases (GHGs), evolving stakeholder expectations, and associated legal or regulatory changes.

Climate Intelligence for Banks: How safe are the banks against climate risks?

Climate Intelligence is a data-driven methodology that allows algorithms to make accurate predictions.

These algorithms pertain to the patterns in a given data set such as statistics, emission factors, simulations of climate risks ie., temperatures, flood levels, and storm intensity. The algorithm will learn from that data to come up with real-time quantitative computations and accurate predictions on climate risks impact. For the financial sector, mispricing of risks could expose financial institutions and investors to sudden and large losses.

Across a broad spectrum of asset classes, climate intelligence is vital in portfolio management and risk evaluation aiming towards a low-carbon economy. Hence, seeking help from experts and promising companies that offer Climate Intelligence is a viable solution to help alleviate climate risks.

CLIMATIG provides a service that gives reliable forecasts of climate change impact on a particular geolocation. It offers solutions through Artificial Intelligence and Machine Learnings strategies to calculate maintenance cost estimates.

For instance, a bank can get accurate data on the expected impact of increased tropical cyclone activity on property destruction in one of its real estate bonds and equities portfolios. CI is thus fundamental in asset management and reallocation of investments i.e. Green bonds.

In view of bank loans, CI can also assess lending patterns by collecting reports and data on lending portfolio climate performance. As European banks transition to a zone of institutionalisation, CI will help align financial institutions using the right tools and low-carbon footprint in operating with net zero emissions.

Climate Risks: Through the Lens of Financial Sectors

Global financial markets are using applied science to measure and guide investments in response to, phenomena attributed to climate change, which influence supply chains, production capacity, and fundamental aspects of supply and demand.

The connection between climate change and banking will continue to have a  growing effect.

In order to relieve negative outcomes of climate risks to financial systems and the economy, effective climate risk management should be implemented across global banks. Financial sectors need climate intelligence to come up with smart data-driven predictions and efficient strategies.

Contact us here and find out more on how CLIMATIG can help you navigate these risks.

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