Are banks prepared for climate change?

In order for commercial lenders to both prepare for climate risk and continue to be seen as a trusted partner to the businesses they lend to, they need to work with borrowers to help them understand their climate sensitivity and vulnerability, and how climate change may impact their future credit worthiness. However, as climate change is still such a new area for the industry, it's hard for banks to build climate-confident teams

Managing climate risk is quickly becoming one the most significant challenges banks are facing. When looking at commercial lenders specifically, how they prepare will come to define them, with fast movers likely to be better positioned to capitalise on the opportunities it will bring.

Regulation

Adapting to an ever-evolving regulatory landscape will be vital for the preparedness of banks. For example, US regulator, the Office of the Comptroller of the Currency (OCC) proposed principles specifically for larger lenders in December last year, that are intended to support efforts to manage key aspects of climate-related risk management within the agency's existing risk management framework, including principles for risk assessments across risk categories.

Following this, its Acting Comptroller, Michael Hsu, said these draft principles are "just a starting point" and will be finalized later this year – heightening the need for readiness across the banking industry. Furthermore, he added that for midsize and community banks, it will be "a number of years before OCC examiners conduct climate risk management examinations" but cautioned bankers to "use the time wisely", developing thoughtful, tailored assessments of their climate risk profiles.

With these factors in mind, coupled with pressures we're seeing that firms are receiving from their boards and investors, it's encouraging to see banks of various sizes choosing to act now, rather than waiting for regulation to come.

Expertise

In order for commercial lenders to both prepare for climate risk and continue to be seen as a trusted partner to the businesses they lend to, they need to work with borrowers to help them understand their climate sensitivity and vulnerability, and how climate change may impact their future credit worthiness. However, as climate change is still such a new area for the industry, it's hard for banks to build climate-confident teams.

So many new skillsets are required for commercial lenders in terms of data science, new modelling techniques, understanding how some of these new green technologies work, etc. and there's simply not enough people in the industry (yet) with the depth and breadth of expertise needed. Banks need to be coaching their front line to have transition-related conversations with clients, providing them with the right questions to ask for different industries and sub-sectors, and using the data from these discussions as one of several inputs to help inform decision-making.

Additionally, because most firms don't yet have the depth and breadth of expertise, they're trying to get every team involved – credit, risk, ESG, the C-suite, the Board, etc. This can be incredibly challenging as different teams will have different priorities and processes. Some may be more interested about the growth opportunity in the loan book, while others may be more concerned with the risk it presents. Some may wish to stop lending to certain sectors which are seen to be more polluting, while others will want to slowly move away from these.

Data

When it comes to managing climate risk, one of the biggest hurdles banks will have to overcome is data. Borrower data is often incomplete, outdated, or simply unavailable and requires manual data entry which can result in duplication of data and errors. Data is usually stored across multiple systems (and in folders and files of bankers) with no consistent view of data. As more and more data is created, additional data challenges arise around: variety, velocity, veracity, and volume. In order to make a big step forward in their preparations in terms of effectively examining the effects of climate change at the counter-party and exposure level, banks will need to gather much more granular data than they currently have. Banks that are more aggressive in trying to develop data taxonomies and mine the data they have, will have a good feedback loop into the policy process.

As these standout themes highlight, there is lots for commercial lenders to do in terms of ensuring they're prepared for climate risk. We are working with a number of banks which are leveraging our Climate Impact Framework to help them overcome and address some of the challenges outlined in this article.

(The author is Director (Product - Climate Change Risks and Opportunities) at OakNorth)