Why climate change is on your banker’s mind

In the aftermath of the 2007/8 financial crisis, Hugo Chavez the former president of Venezuela famously said that if climate was a bank, they would already have saved it. He was making the point that in the hierarchy of urgent and important global goals, bailing out banks far surpassed climate problems.

Eighteen years later, we live in a world where banks have themselves become a crucial force in addressing climate change. In fact, major leaguers like JP Morgan Chase, Deutsche Bank, Barclays group, Bank of America and HSBC have become members of the Net Zero Banking Alliance.

This alliance represents more than 40 per cent of global banking assets which makes their net zero commitments very consequential.

You may be wondering what the nexus is between banking and climate risks. One major linkage is the fact that the biggest contributor to emissions (over 70per cent) is the use of fossil fuels and companies in the fossil fuel sector receive substantial bank loans.

According to a Financial Times article, the world’s 60 largest private sector banks have pumped an estimated $ 3.8 trillion into this sector from 2015 to date. It follows that if banks reduce their financing for these brown investments and ramp up credit to green energies and technologies, then emissions can be expected to reduce significantly.

One obvious concern is whether there is a big enough pipeline of bankable green projects/ investments to absorb the growing pot of green money.

A second concern is whether an extremely rapid shift away from fossil fuel investments could destabilise not just the oil, gas and coal sector but the financial one as well.

Balancing between the need to take urgent action on decarbonisation and the need to ensure stability during the transition phase makes the role of regulators such as central banks very important.

In the Kenyan context, the Central Bank of Kenya (CBK) issued its Guidance on Climate-Related Risk Management in October 2021.

The CBK guidance is constructed around the four pillars in the Task Force on Climate Related Financial Disclosures (TCFD) publication dated October 2021 namely, governance, strategy, risk management and metrics/ targets.

A robust governance structure is certainly required to ensure that an institution properly assesses climate risks and opportunities. To give this issue the attention it deserves, the CBK parks it squarely at the board table.

There may be a temptation to hire a chief climate officer, but he/she cannot go it alone – the board has to meaningfully consider climate matters and take ultimate responsibility for them. We would not be surprised to soon see separate and dedicated board committees responsible for ESG and climate matters.

The board is responsible for overseeing the development of a climate risk and opportunity strategy while senior management is responsible for implementation. Formulating the strategy is informed by understanding the climate-related risks in the business environment and the horizon for those risks.

This is why the devil is in the detail when it comes to the element of risk assessment. There are myriad risk drivers surrounding the extent to which capital is deployed to brown versus green investments.

For example, if a bank has significant exposure to a carbon-intense borrower, it needs to consider the credit risk associated with weaker performance or reduced market share due to adverse public perception, the risk that the value of the borrower’s collateral will reduce due to shrinking demand for such assets and the legal liability risk of being sued for sponsoring environmental harm.

In its guidance document, the CBK has demarcated the parameters for the risk management framework but has avoided being too prescriptive. It is the institutions themselves that must identify, measure, monitor, report, control and mitigate climate-related risks which impact their portfolios and operations.

The risk assessment process should factor in the materiality and probability of the potential impacts identified.

The comprehensive nature of the climate risk assessment calls for a data-driven approach which in turn presumes that the banks have been maintaining the relevant information in a manner that allows it to be easily mined and analysed using apps.

The risk assessment process also calls for access to subject matter experts as some of the interpretation of the data will inevitably be subjective.

Once a clear strategy is in place based on a thorough risk assessment, the next step is to implement the strategy and reliably monitor the progress made. This is where climate change metrics and targets come in.

They are essential for accountability because as they say, what gets measured gets done, so setting reasonable yet impactful targets is pivotal. With allegations of greenwashing becoming more rampant, banks need to think carefully about their target setting to make their successes taint-proof.

From the TCFD publication, we see some examples of metrics used by banks to disclose their climate risks. For example, a bank can report its financed emissions and fuel mix over a number of years to demonstrate a greener trend.

Banks can also report on their exposure in relation to mortgaged properties which are in zones that are at risk of coastal flooding or severe droughts etc.

In terms of target setting, lenders can commit to reaching certain sustainable finance investment targets by 2030 or specify the level of investment in particular areas like ecotourism or electric vehicle manufacturing and charging infrastructure.

KCB #ticker:KCB for example has committed to increasing its green lending portfolio by 5 per cent annually over the next five years and to stop lending to businesses and projects that pollute the environment.

From an internal consumption perspective, a bank can also have targets for green procurement such as using a car fleet consisting of lower emission models, ensuring that tea and coffee are purchased from certified sustainable producers and using renewable energy to the extent possible at its sites.

From a bank customer perspective, banks can offer incentives to reward climate-conscious behaviour such as offering lower rates of interest for financing solar power solutions, leasing low emission machines or construction of energy efficient buildings.