A new report reveals the potential exposure from physical climate change impacts to just the syndicated loan portfolios of 28 of the largest U.S. banks could approach 10 percent annually.
Financing a Net Zero Economy: The Consequences of Physical Climate Risk for Banks provides valuable insights to help the sector realize the systemic implications of physical risk and sets out a practical roadmap to help banks conduct risk assessments and incorporate climate risks into their day-to-day decision-making. Its recommendations were developed out of an illustrative analysis conducted by the sustainability nonprofit Ceres and consultants from CLIMAFIN that used natural catastrophe and credit risk models adjusted for climate effects, macro-economic data, and publicly available syndicated loan information for major U.S. banks.
The new report analyzed $2.2 trillion of exposure for syndicated loans and found the physical risk to major U.S. banks could amount to more than $250 billion annually. It also revealed two-thirds of banks’ physical risk comes from the indirect economic impacts of climate change, such as supply chain disruptions and lower productivity, with coastal flooding (driven by sea level rise and stronger storms such as Hurricane Ida, which just devastated New Orleans’ power grid and left more than 1 million residents without power) representing the largest source of direct risk.
“While the industry has taken steps to mitigate climate change risks, the enormity of these threats means banks and bank regulators still have much work to do,” said Dan Saccardi, senior director of the Ceres Company Network at Ceres. “The sector must stop treating the climate crisis as a reputational risk with minimal financial implications and instead reconsider how today’s financing activities, risk management, and strategic planning can help banks minimize economic instability and disruption in the long-term – for themselves, the economy, and broader society.”
Financing a Net Zero Economy: The Consequences of Physical Climate Risk for Banks offers detailed recommendations across four broad categories to guide the banking industry in fully measuring, analyzing, and acting against threats posed by the physical risks of climate change (full recommendations can be found on pages 9-10 of the report):
Assess and Measure Physical Climate Risk
- Assess all elements of climate risk and opportunity
- Measure the current impact of natural disasters on the value of financial assets
- Project the future cost of climate change
- Perform climate stress tests
- Collect asset-level data about exposure and loss vulnerability
- Build connections with external experts
- Integrate climate into product and service pricing
- Engage clients on physical risks
Capitalize on Opportunities
- Understand the changing insurance landscape
- Focus on adaptation projects to mitigate credit risk
- Develop innovative adaptation financing solutions
- Advocate for smart financial regulatory and policy actions on adaptation
Meet the Moment
- Set and disclose financing portfolio targets
- Publicly commit to and begin work on the 13 recommendations above within the next year.
“The risk uncovered by Ceres’ report is significant, but it’s only a piece of the puzzle: We examined syndicated loans because public data is abundantly available, but this represents only a fraction of banks’ portfolios,” said Steven Rothstein, managing director of the Ceres Accelerator for Sustainable Capital Markets. “And, physical risk has potential implications for other asset classes, which is why more work is needed by banks to develop holistic understanding of the risk that exists within their respective portfolios. With the right strategic approach, addressing physical risk can lead to opportunities in adaptation finance, and the banks that lead in this work can create significant new value for their institutions, clients, and the broader economy.”
“Considering the uncertainty that climate change introduces regarding the trend in intensity and frequency of weather events, banks are dedicating resources to understand the impact of different climate scenarios and how those translate into financial risk measures,” said Martha Raber, executive vice president/managing director and head of financial risk activities for Regions Bank. “Financial institutions are contemplating climate risk disclosures and the use of firm-level data to better understand physical climate risk’s materiality to their operations and their clients.”
The report’s analysis echoes that from Ceres’ 2020 report on transition risk in the banking sector, which found that more than half of bank lending is exposed to transition-related climate risk and indicated that banks that fail to prepare for the energy transition face far higher risks than what has been disclosed. This is even more critical for community banks and credit unions, whose loan portfolios are more exposed due to their geographic and sectoral concentration.
Ceres is actively working with several financial regulators, including the Federal Reserve, the U.S. Comptroller of the Currency, the National Credit Union Administration, and several state banking officials to address their responses to climate risk. Additionally, in the wake of Ceres’ transition risk report, the organization has worked with many leading banks to help them examine their transition- and physical-related climate risk.
The report comes one week after Ceres launched Ambition 2030, a new effort aimed at decarbonizing the banking sector, along with five other high-emitting sectors: electric power, food, oil and gas, steel, and transportation—which together are responsible for up to 80% of global emissions. Transforming these sectors is necessary to reach the collective global goal of limiting temperature rise to no more than 1.5 degrees Celsius and achieving a more just and inclusive economy.