Climate change: NAB and ANZ up the ante on disclosure

National Australia Bank and ANZ have teamed up with the world’s top banks to developed new ways of assessing the physical impacts of climate change on their loan portfolios.

The methodologies are designed to enable banks to be clearer about their exposure to climate-related risks in line with the recommendations of the Financial Stability Board's Task Force on Climate-related Financial Disclosures.

Using this approach, banks can assess the impacts of climate change risk on borrowers’ revenues, costs and property values and estimate how these changes could affect the probability of default and loan-to-value ratios at a borrower and portfolio level.

The report was released on Tuesday by the UN Environment Finance Initiative (UNEP FI) which brought together 16 banks to work on the stress tests.

The report's authors noted that extreme events - which are increasing in both frequency and intensity - often attract more attention within the insurance sector as their impacts are more obvious.

However, they warned, risks from incremental changes, which are already underway, should not be overlooked.

In contrast, to extreme weather events that may only occur in specific locations - such as floodplains or hurricane regions - incremental changes have the potential to gradually erode the financial performance of entire borrower segments.

“Understanding these phenomena and how they translate into financial risk and opportunity is fundamental to banks' strategies to increase their resilience to a changing climate," the report’s authors said.

Changing customer demands

Banks can also begin to evaluate the growing opportunities to support borrowers’ finance requirements in adapting to changing conditions.

Also,  clients who face physical risks may need to make investments to become more climate-resilient.

"As Australia’s largest agri-business bank, banking one in three farmers in Australia, we understand the seasonal nature of the industry, and the challenges our customers face operating in one of the driest continents in the world,” said David Gall, NAB’s head of risk.

“Climate projections indicate these challenges will grow, so it’s vital we continue to understand the impacts and opportunities presented by the physical impacts of climate change, to proactively manage future risks and develop opportunities for adaptation and building resilience.”

According to Kevin Corbally ANZ’s chief risk officer, while ANZ is still in the early stages of testing the new approach he expects it will be a useful framework to inform the bank’s ongoing discussions with customers regarding their climate-related risks and opportunities.

The report’s authors warned that there were limitations and challenges in the methodologies which will be addressed in future iterations.

Role of insurance

Remarkably, after highlighting the importance of insurance as a risk mitigant (and pricing signal), insurance has been excluded it from the analysis due to uncertainties about present-day coverage and future changes in insurance availability and pricing.

“Research undertaken for the pilot project found that publicly-available data on present-day insurance uptake across commercial sectors and regions are scarce.

“This makes it difficult to develop a comprehensive picture of how insurance currently mitigates these extreme events for banks’ commercial borrowers.”

The report's authors argued that concrete evidence of insurers having narrowed or withdrawn coverage in the past following extreme weather events, which may give some indication of how insurance markets may react to future changes in these events.

At first glance, this seems odd since most of the lenders are running both banking and insurance lines. However, after carrying out research and meeting with a range of insurers and re-insurers they decided to conduct a separate project with insurers to address these issues. 

In Australia, NAB and ANZ met with the peak industry body, the Insurance Council of Australia.

Barclays, BBVA, Citi, Standard Chartered, UBS are amongst the banks currently piloting the new approach to stress testing for climate change risk.

An earlier UNEP FI report addressed the lack of public data for banks to assess climate risk exposures given that most climate scenario models are not designed for financial risk assessment. 

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