Climate change: the new risk variable

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Climate change is happening, and its costs and risks need to be built into bank’s risk management practices.

To respond to climate change, bank’s risk management practices need to go beyond minimal regulatory compliance. Banks need a framework to viably finance businesses and industries that are at the heart of the economy.

In this paper, we discuss how companies are going to be hit by the costs of compliance and the impacts of climate change, while at the same time facing an unknown financing regime as banks attempt to transition to banking within a sustainable economy. Although surrounded by the many uncertainties of climate impacts and mitigation, this model needs to add climate risk factors into its traditional approaches for managing risk-weighted assets and credit risk. There are solid foundations for this, with mitigation pathways and risk analyses widely available. Modeling, however, is complex and must recognize that the cost of dealing with policy change for a business is separate from the cost of addressing the physical impacts of climate change on that business. Despite this, it’s possible to create a framework to ‘green’ the balance sheet that captures the economic picture of the transition to a zero carbon economy.

Resilience is a common factor across the financial system, and in this paper, we also look at how different players from central banks to credit officers can use a shared language of climate resilience to achieve their goals.

Although the challenge of financial resilience in the face of climate change is daunting, the technology solutions have become much more accessible. With cloud based platforms and open APIs, banks can integrate new functionality to respond with agility and use advanced fintech apps that bring the capabilities they need to ensure climate change risk is properly represented in their balance sheets.