Climate change rules put bank lending books in spotlight

New global disclosure recommendations on financial risks has revealed the growing climate change risks that banks could confront with their residential loan portfolios, according to a recent report by Deloitte. 

In late June, the Taskforce on Climate Related Financial Disclosures (TCFB) from the Financial Stability Board (FSB) recommended that businesses should disclose climate related financial risks in mainstream financial statements. 

The FSB reports into the G20 which is concerned about how best to mitigate the global risks of climate change.

“While the TCFB disclosure recommendations are presently voluntary, we expect that investor and competitive pressure will lead companies to adopt these standards,” Deloitte insurance actuary Sharanjit Paddam told AB+F

“It’s speculation at this stage, but over time such requirements could be mandatory for companies around the world.” 

Physical risks 

The FSB’s taskforce considers climate risks in two categories: risks related to the physical impact of climate change and risks related to the transition to a lower-carbon economy.

Transition risks arise from policy change, technology change and reputation risks. Paddam said that for financial institutions, this investment risk is likely to be the most significant risk from climate change in the short to medium term. 

“In the longer term, lower economic activity due to transition to a lower-carbon economy may also become significant, for example, reduced bank lending to tourism and mining industries as customers.

It is the first risk, however, where the banks could be vulnerable in terms of their residential portfolio. 

*The warning for Australian banks is that they have higher concentrations of residential lending assets than any other developed nation

“Physical risk is important for banks – including insurers and other financial institutions - that invest in property.  Increased natural disasters may result in increased maintenance costs, increased insurance costs and loss in the value of property assets that are no longer accessible or useable. 

Bank warning 

A recent example were the properties in Narrabeen, a suburb on Sydney’s northern beaches that experienced severe coastal inundation in May last year. It was estimated to cost in the hundreds of millions of dollars. 

Paddam points out that while insurers can reprice the risk on an annual basis, it is “perhaps worse for banks since home loans are written for longer periods with no annual repricing”. 

“Higher insurance and maintenance costs may lead to serviceability issues on loans, and increased coastal inundation (which is not covered by insurance), may result in higher defaults and losses.” 

Under the Taskforce’s climate disclosures recommendations, companies must undertake scenario testing, to measure the impact on their financial position, and to set strategies to mitigate any adverse impacts and seize commercial opportunities.

“The warning for Australian banks is that they have higher concentrations of residential lending assets than any other developed nation,” Paddam said. 

Working with APRA 

According to Paddam, the issue of disclosing climate change risks is starting to hit the radar of many banks.

“We have been in discussions with a number of banks on this issue. APRA is also working with both banks and insurers to help them understand what is required,” Paddam said. 

Climate change was a hot button issue at the inquiry into the major banks by House of Representatives Standing Committee on Economics in March. 

Australia and New Zealand Banking Group chief executive Shayne Elliott acknowledged the risks and told the committee that the bank was looking at climate risks in its mortgage business. Similarly Commonwealth Bank chief Ian Narev also said the bank was monitoring the exposure of its loan book to climate change.

Their comments followed remarks made by Geoff Summerhayes, executive board member of the Australian Prudential Regulation Authority show said that the financial system faces material risk in a warming climate change. 

A full report by Deloitte on the TCFB disclosure recommendations will be featured in the August edition of AB+F. 

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