By Paul Gores
Efforts to mitigate climate change are under way globally, and banks of all sizes would be prudent to prepare for regulations that climate concerns are bound to spur, experts say.
Getting ahead of the curve now will give banks time to develop a thought-out strategy rather than having to deal with it quickly as mandates are issued, according to speakers at a recent Marquette University banking conference titled, “Climate Change: What are the risks, realities, and challenges?”
Although at this point only banks with assets of $100 billion or more are being targeted to include climate risk considerations in their examination routines, eventually those rules will find their way to smaller banks and credit unions, said Kent Belasco, the director of Marquette’s commercial banking program, which hosted the online conference this spring.
Belasco, who has held annual commercial banking conferences on topics such as cybersecurity, financial crimes, and fintech, said he felt the time was right to look at what banks need to know about the eventuality of regulations focused on climate change.
“What I wanted to structure was just purely an informational session that says, OK, it may not be affecting me from a regulatory standpoint right now, but me, as a former banker, I knew that whenever the Fed started talking about something — even if they said it’s not going to affect you right now — it will, and you better get prepared for it,” Belasco said in an interview for the Wisconsin Bankers Association about the event.
Speakers at the Marquette conference were in agreement there is no doubt climate change risks and regulations for banks are coming, and banks should not only prepare for inevitable new rules, but also consider the transition to sustainable fuels and lending to greener businesses a growth opportunity. They acknowledged it may seem intimidating at first, but said banks can adapt.
“You guys have navigated really tough crises in the past, and here you are,” said Ariana Gomez, founder and chief executive officer of the consulting firm Technology for Impact.
She said bankers should ask themselves how they can be “an accelerator” in the transition.
“Because you hold the money at the end of the day. How can you be an accelerator here and grow your own business by doing the right thing?” Gomez said.
Michael Cohn, a principal at the Boston-based consulting firm Wolf & Company, said some companies he works with are early adopters that see what’s coming.
“They clearly see social and societal and consumer behavior beginning to drive the selection of companies that they want to do business with,” said Cohn. “They are not afraid of moving forward, even in the face of all the ambiguity that still exists out there.”
He said management teams for those companies know that if they move early, they can take their time to develop plans.
“And if they take their time and they can be thoughtful, they will be able to implement these programs at less expense,” Cohn said.
One hurdle that could keep some banks on the sidelines for now is the political debate over climate change. Not everyone is yet convinced it’s a risk they should have to account for — or in some cases, whether it’s even the great threat many consider it to be.
Shareholders at three of the nation’s biggest banks — Citigroup, Bank of America, and Wells Fargo — this spring voted down proposals aimed at reducing their lending to new fossil-fuel projects.
However, the proposals cleared thresholds to qualify for resubmission next year, according to a report by American Banker.
Regardless of the politics around climate change, many nations, including the U.S. government and its agencies, are taking it seriously. In the U.S., efforts are starting to come from various federal regulators, including bank regulators. While the focus now is on the biggest institutions, it will widen, the experts said.
In December last year, the Office of the Comptroller of the Currency released a document, “Principles for Climate-Related Financial Risk for Large Banks,” aimed at banks with more than $100 billion in assets.
“At the same time the OCC said that all banks, regardless of size, may have material exposures to climate-related financial risks,” environmental attorney Jason Lichtstein said during the Marquette conference.
Climate change, simply put, is the long-term change of weather and temperatures resulting from the burning of fossil fuels. Greenhouse gases from fossil fuel consumption move into the earth’s atmosphere and capture heat from the sun, causing the global temperature to rise.
Lichtstein, citing the National Oceanic and Atmospheric Administration, said climate change impacts are happening now and increasing in scope, frequency, and intensity. In 2020, there were more than $22 billion weather and climate disasters in the U.S., a record, he said.
“From 1980 to 2021, there was an annual average of 7.7 events, and the annual average for the most recent five years, from 2017 to 2021, was 17.8 events,’’ said Lichtstein, whose practice with the national law firm Akerman LLP focuses on the cleanup and redevelopment of brownfields and other contaminated sites.
The international goal is to hold the global temperature increase to no more than 2.7 degrees Fahrenheit by 2050.
The Biden administration is seeking to reduce U.S. greenhouse gases by 50% to 52% from 2005 levels by 2030. The longer-range goal is net zero emissions by 2050. Net zero means producing less carbon than we take out of the atmosphere.
Industries producing the most greenhouse gases are energy, transportation, manufacturing, building, and agriculture.
The fallout from climate change includes higher sea levels and more destructive storms, floods, and wildfires. Among financial risks include potential market and credit losses, equity and bond price declines, carbon asset write-downs, falling property values and the costs of transitioning to cleaner energy.
A 2019 report by the firm Oliver Wyman, “Climate Change: Managing a New Financial Risk,” stated that in addition to operational and market risks, climate change can lead to increased credit risk for banks. The report said, for instance, that mortgage portfolios could be hit by events that reduce property values.
In a report last year, the Wisconsin Initiative on Climate Change Impacts, which is a statewide collaboration of scientists and stakeholders formed as a partnership between UW-Madison’s Nelson Institute for Environmental Studies and the Wisconsin Department of Natural Resources, said that since 2011, data in the state showed continued warming, increases in rain and snow, and more-frequent extreme rainfall events.
“Statewide temperatures have warmed by about three degrees Fahrenheit and precipitation has increased by nearly twenty percent since 1950,” the report says. “In the last decade, nearly every region of the state has experienced extreme rainfall events that led to flooding of roads, homes, businesses, and farm fields.”
The Wisconsin report said, among other concerns, that warmer winters, increasing deer herds, extreme weather events, summer droughts, and longer growing seasons are stressing forest ecosystems and increasing the risk of outbreaks of new pests and diseases.
“Iconic species like the paper birch are vanishing from northern forests as the climate warms,” the report says. “Forest management, logging, and the forest products supply chain are facing uncertainty, with implications for rural economies.”
In the future, banks are likely to be required to account for how their lending — the businesses they lend to — could affect climate change. They also are expected to have to account for whether their key third-party vendors are complying with efforts to mitigate climate change, participants in the Marquette conference said.
“We are observing all the time that nobody has yet put in good solid detailed vendor due diligence and vendor monitoring practices over whether their vendors have put in climate risk management programs,” Cohn said. “Nobody is there yet. It has not worked its way into one of the most basic risk management activities, which is monitor your vendors.”
Governments around the world are pushing for mandatory climate risk reporting, said David Carlin, who leads the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures and the climate risk program for the United Nations Environment Programme Finance Initiative.
The task force has designed standardized guidelines to help organizations disclose material climate risks, explain plans to manage exposure, and describe how the shift to a zero-carbon economy would affection their operations.
“What we’re seeing is that there’s a lot of work on getting boards up to speed, getting executive leadership involved in the climate risk process on the governance side,” Carlin said. “On the strategy side, climate opportunities are an area that has been of increasing interest, and strategies are explicitly being developed alongside sustainable finance frameworks to bring those things to fruition.”
Unlike risk scenario analysis that can rely on the past to project what is likely to happen, climate change is dynamic, which makes it more challenging to predict risks.
One thing all banks should be aware of is that the customers and employees of the future — millennials and Gen Z — want their banks to be mindful of climate change and involved in slowing it. Those groups are “looking for places with purpose,” said Gomez.
“They want to work and earn a salary, but they also want to transcend, to have positive impact on the planet,” she said.
Belasco said he also has seen that motivation in college students he has trained.
“There is no doubt that millennials and Gen Z are hyper focused on the products and services they use and what is the impact to the environment when they go ahead and use them,” Cohn said.
Cohn said it’s time for banks to consider the risks that come with climate change.
“When we talk about climate and credit, we are worried about are we going to wind up with defaults because of companies that either are not making transitions, or they are so fossil fuel dependent that the markets and consumers move completely away and they cannot pay us back,” Cohn said.
He said banks need to analyze who they’re going to do business with in the future, even though brown industries and the world aren’t ready yet to shed their usage of fossil fuels. Banks must consider migrating funding to new green industries and slowly wean some of the brown industries.
“That’s where the banking system and banking, both at a national, regional, and community level, can have the biggest impact — because there are a lot of small companies out there that are doing the right thing,” he said.
It will be important for banks to establish — and soon — a panel or person to oversee the bank’s climate change efforts and set up a process for identifying, assessing, and managing climate-related risks, Cohn said.
“Committees provide two things: They provide oversight and they provide the approval for the provision of resources,” Cohn said.
Executives need to make sure climate risk is something everyone in the organization is on top of, although the chief risk officer probably is going to be “the orchestra leader for these plans,” Cohn said.
Cohn said even though it might seem overwhelming at times, banks should get started now because the pace of change isn’t going to slow down.
“The world right now is moving likely at the slowest rate of change it will for the rest of our lives,” he said.
Gores is a journalist who covered business news for the Milwaukee Journal Sentinel for 20 years.
As bankers in Wisconsin can attest, having the knowledge of, and experience managing, the risks their customers may face is a key component of effectively running a bank. For generations, bankers across the state have assisted their customers in managing various types of risk, including climate-related risks. However, as policymakers, investors, and customers grow concerned about the impacts of climate change, several regulators have signaled forthcoming regulatory action.
By Jeff Gruetzmacher
