Why banks must develop climate strategies

21 May, 2019Dr Ben Caldecott

Why-banks-must-develop-climate-strategiesBen Caldecott explains why new changes to banking supervision mean climate change must now be treated as a strategic issue by all UK regulated banks.

The banking sector is where the financial system and the real economy meet. Banks provide loans and services critical to companies, households, and governments. The United Nations’ Sustainable Development Goals (SDGs) and the Paris Agreement on climate change are unattainable without banks financing solutions to these massive social and environmental challenges.

Nor can we have efficient, fair, and resilient financial and economic systems if banks fail to manage and reduce environment-related risks for themselves and for their clients.

How banks view environmental risk

In September 2018 the Bank of England published results from a survey of 90% of UK regulated banks representing over £11 trillion in global assets. The survey was designed to see how these banks view climate-related risk, an important subset of environment-related risks.

It found that while 70% of banks recognise that climate change poses financial risks, only 10% view climate change more holistically and take a long-term strategic view of the risks. Disappointingly, 30% of banks still consider climate change as only a corporate social responsibility (CSR) issue with little or no relevance to business strategy or operations.

Although only 10% of surveyed banks viewed climate as a strategic issue, the survey in fact highlights how quickly climate change has shot up the agenda for banks. Few (if any) banks anywhere in the world would have viewed climate change as ‘strategic’ five years ago.

Climate change has gone from merely being one CSR issue that banks consider to a topic of concern for risk management, client relations, investor relations, product development, government affairs, and marketing, among other areas.

In other words, climate change is now seen as increasingly relevant across a banking business and therefore needs to be managed in that way by senior executives and the board.

How to get banks to take climate seriously

The survey also highlighted how we still have a long way to go. How long will it take to go from 10% of banks viewing climate as strategic to 100% seeing it that way? And while viewing an issue as strategic is important, what does that actually mean in practice? How do we achieve a transition in how banks think about these issues and simultaneously achieve significant changes in practice too?

A number of factors are shaping how banks think and act on climate change, including changing client demand, new data and analysis capabilities, fintech developments, and new professional standards. Financial regulation and supervisory expectations will play a critical role too, as new regulations now make clear.

In April the Bank of England published a new supervisory statement for UK regulated banks and insurers. This means that UK regulated entities must have comprehensive plans to manage the financial risks of climate change and designate responsible managers under the Senior Managers Regime. Regulated firms will need to submit plans and identify responsible individuals by 15th October 2019.

This change in regulation and supervisory practice is impressively comprehensive. It means all UK regulated banks (and insurers) need to have capabilities and tools to measure and manage climate-related risks, including short- and long-term scenario analysis. It means that banks will need to disclose these risks and have clear lines of responsibility for the management of such risks, including at the board level. It also sets out clearly that the stringency of supervision will ratchet over time as practices evolve.

This is a major development and one I expect will be quickly replicated across jurisdictions represented in the Central Banks and Supervisors Network for Greening the Financial System (NGFS).

The NGFS was launched in 2017 and now includes 36 central banks and supervisors - representing five continents, half of global GHG emissions, and the supervision of two thirds of the global systemically important banks and insurers.

Banks and climate strategy

The real economy cannot transition in time to meet the SDGs and the Paris Agreement without the banking sector providing the capital and services needed.

Banks need to develop comprehensive climate strategies, together with detailed plans for implementation tied to appropriate resourcing and levels of accountability to ensure implementation.

This will likely become a mandatory regulatory requirement for all banks, and this is now already the case in the UK.

Ben-CaldecottDr Ben Caldecott is founding Director of the Oxford Sustainable Finance Programme and an Associate Professor at the University of Oxford, as well as Co-Chair of the Global Research Alliance for Sustainable Finance and Investment.

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