Banks’ response to ESG issues is hampered by a lack of industry-specific standards, agreed upon and relevant metrics or leading practices to guide them and establish credibility. Response efforts could be further complicated if, as some bankers fear, governments lean heavily on banks to lead their countries’ transitions to carbon neutral economies. A participant said, “I’m very loathe that the banking industry should be seen as the leader of government policy. Ultimately, the people elected by society will have to do something related to policy. It’s government that needs to lead.”
Coordination is needed across the sector
The banking sector would benefit from more collaboration. A participant said, “I’d like the industry to share more best practices. If we worked together more, we could impact policy.” Several participants said regulators could help to improve coordination and information sharing. One said, “One of the biggest challenges right now is simple benchmarking and trying to figure out if we’re doing enough. Regulators are uniquely positioned to collect information from the banks and share good practices.”
Determining institutional exposure is difficult
Firms are in the early stages of determining their direct exposure to climate change, which is critical to developing an effective response. Understanding certain risks is fairly straightforward, such as credit exposure to key players in the fossil fuels industry. But, it is far more complicated to estimate exposures to climate change more broadly. Participants discussed the ways that climate risk could manifest:
1. Physical risk
Physical risks arise from increased destruction of property, loss of asset value, loss of economic activity, and declining global incomes. Banks are trying to determine their direct exposure to physical risks through financial instruments, such as mortgages and other real estate investments, which might be particularly vulnerable to climate events.
2. Transition risk
Transition risk stems from efforts to transition to a low-carbon economy, spurred by policy, technological developments, or public opinion. The scope of this risk is potentially vast. A study by the Network of Central Banks and Supervisors for Greening the Financial System estimates the losses associated with the devaluation of assets as a result of transitioning to a low-carbon economy could be as much as US$20t.2
3. Reputational risk
Given public sentiment and attention to climate issues, reputational concerns could be as significant as the direct risks of climate transitions that we see manifesting themselves during this pandemic.
More banks are starting to incorporate these risks into their risk program. In our Tenth annual EY/IIF global bank risk management survey with the Institute of International Finance, over a quarter of banks have already done so, with 14% and 12%, respectively, quantitatively assessing physical and transition risks.3
Strategic questions persist
Whether the planet truly faces a “climate emergency” is still debated and politicized across countries and stakeholders. Some bank leaders have argued that their institutional exposure to climate risk is mitigated because loan books turn over relatively quickly, which gives them time to adjust as risks evolve.
Ultimately, each bank must decide how proactively it wants to address climate change, and it is without question a complicated decision. One bank leader noted that even seemingly straightforward initiatives, such as divesting from fossil fuels, are in reality quite complex. “We cannot just cut the energy off in Poland, where a lot of the economy is still powered by coal.”4 Several participants advocated for engaging clients about the sustainability of their business models and transition strategies. One participant said, “Oil and gas is an enormous industry and it is still the foundation of many economies. You can’t just turn off that tap overnight. So as banks, the question is how do you help them to transition?”