Climate change and bank risk management

Banks are reacting to accelerating climate change initiatives, where regulators (including the US, UK and Europe) are providing stimulus. It is becoming incumbent on banks to address climate change risk from a multi-dimensional perspective, encompassing policy on climate change risk management, a strategy incorporating this policy, a tactical approach to implementation, customer origination approach, balance sheet risk management approach, and regulatory compliance. This paper seeks to explore, based on practical experience, how climate change risk should be embedded into bank risk management.
Banks face an obligation to state and follow a Board-level approved Climate Change Risk policy. Drivers of this include: i) regulatory compliance: supervisors have pronounced on this so banks must comply with published guidelines; ii) market expectations: a growing majority of customers, shareholders and other external stakeholders are aligned with climate change and expect their bank to be proactive in this area; iii) business opportunity: there are growth and RoC-related benefits to adapting existing and/or implementing new products and services that address the global economy’s shift to more environmentally friendly business.
From a practical management-level and operational perspective, the imperative is to assess, understand and apply what this means for a bank’s risk management framework (RMF). Impacts are to be expected in the areas of governance, risk management, scenario analysis and stress testing and disclosure.
In theory at least, virtually all risk disciplines are impacted by climate change risk, including market risk, credit risk, liquidity risk, operational risk, and reputational risk. There are several elements to be addressed in an effective climate change risk approach embedded in a bank’s RMF: risk strategy, risk governance and frameworks, risk policies and standards, risk assessment and identification, risk measurement, appetite and limits, identifying and executing strategies, specific pricing for climate risk and climate related loan and deposit products, monitoring exposures, and reviewing and measuring performance.