• Vishwas Khanna and Kavisha Sharma, Associate Partner and Consultant at Avantage Reply


• 27.01.2023 05:15 pm
#RiskManagement

Climate change continues to be an existential threat to the future of humanity. 

Perhaps unsurprisingly, climate action failure, extreme weather events and biodiversity loss have been identified as three global risks anticipated to have the most damaging effect over the next ten years according to the World Economic Forum Global Risks Perception Survey 2022. While the detrimental impact of climate change on global ecosystems has been well-documented, the financial implications and inherent likelihood of disruption have come into the spotlight more recently. 

Tackling climate-related and environmental risks is among financial regulators’ key priorities in the coming years. For banks, this means that the days of relegating climate change to the Corporate and Social Responsibility (CSR) agenda are long gone. The future that has so far been the subject of “preparedness discussions” has finally arrived and banks face significant consequences for inadequate climate risk management practices. 

Last November, the European Central Bank (ECB) shared the results of its thematic review on climate-related and environmental risks of 186 banks with total combined assets of €25 trillion. The review found that banks are still far from adequately preparing for the full magnitude of climate risks facing them. The ECB has set staggered deadlines for banks to progressively meet its supervisory expectations and has warned that failure to address climate-related financial risks could result in higher capital requirements and fines. 

With rising pressure from regulators, banks and their risk management teams need to adopt strategic approaches to address climate risk and improve practices. In our view, here are three of the most pressing tasks that banks need to address:

Implement robust climate governance and risk management structures and processes

As stewards of performance and resilience, bank boards should integrate climate considerations into their structure, committees, decision-making, and risk-management processes. This includes ensuring the availability of adequate resources and sufficient skills and expertise. Additionally, climate-related financial risks must be explicitly included in risk appetite metrics. This quantifies the amount of risk that an organisation is willing to accept in pursuit of its strategic objectives, with appropriate limits and thresholds clearly defined. 

Conduct regular scenario-analysis

Banks should inform their strategic planning with climate-focused scenario analysis, considering climate risk mitigation and adaptation as well as operational resilience considerations. Given that the time horizons over which climate-related financial risks may be realised are uncertain, assessing impacts over multiple horizons is recommended. In addition, where appropriate, transition paths to a low-carbon economy should be considered as part of scenario design with analytics and outputs influencing the target operating model.

Meet regulatory reporting requirements 

The Task Force on Climate-Related Financial Disclosures (TCFD), and indeed many other reporting frameworks, have established approaches for disclosing climate-related financial information. The lack of accurate and reliable data is an obstacle to effective disclosure; banks must invest in the operational transformation required to collect, process, and publish this data. 

The growing impact of climate change requires significant efforts and firm-wide structural adjustments to banks’ operations, not just to meet regulatory and supervisory requirements, but also for institutions to protect their assets and business. 

Decisive action today will foster long-term resilience and capabilities to create a more climate-friendly and sustainable economy.