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Banks need to get ahead of climate change, or else

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Banks need to get ahead of climate change, or else

Climate change

Banks need to get ahead of climate change, or else

Real economy cannot meet sustainability goals without help from financial sector

Climate change is becoming an ever more important strategic concern for banks © PA

Banks are where the financial system and the real economy meet. The UN’s Sustainable Development Goals and the Paris climate change agreement will be unattainable unless banks finance 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 their clients.

Few (if any) banks would have viewed climate change as “strategic” 10 years ago. As recently as last year, the Bank of England found that, while 70 per cent of banks recognised that climate change poses financial risks, only 10 per cent took a long-term view of the risks.And 30 per cent of lenders still considered climate change only a corporate social responsibility issue, with little relevance to business strategy or operations.

Attitudes are shifting fast. For many lenders, climate change has become a topic of concern for risk management, client and investor relations, product development, government affairs and marketing teams, among others.

We still have a long way to go. While climate risks have risen up the agenda, other environment-related risks are also potentially of systemic importance, including those related to nature and biodiversity loss.

There is now growing demand from clients, policymakers and other stakeholders for banks to look beyond risk issues and examine the positive and negative effect of the loans and services they provide on the ability to meet the Paris commitment to keep average temperature rises well below 2C. But how do we ensure both individual banks and the entire sector are making loans aligned with climate goals?

Clearly, executives need to alter practices and standards. That’s something that professional bodies can support with new courses on sustainable finance and by incorporating these topics into existing qualifications and professional standards.

Regulatory change will also spur reform. In April, the BoE said UK-regulated banks and insurers must put in place comprehensive plans to manage the financial risks of climate change and designate responsible senior managers. These regulated entities will need to have the capabilities and tools to measure and manage climate-related risks, including short and long-term scenario analysis. They will need to disclose these risks and have clear lines of responsibility for managing them, including at board level. The BoE also made clear that supervision will become more stringent over time.

I expect the BoE’s move will be quickly replicated elsewhere. The Financial Stability Board’s task force on climate-related financial disclosures, chaired by Michael Bloomberg, is helping drive this agenda globally.

Innovation will also speed up the process of change. The data required to measure and manage environmental risks and impacts is improving. New space-based sensors combined with artificial intelligence will transform the availability of information and change how these risks, opportunities and impacts are managed by financial institutions.

New products, such as loans that charge lower interest rates to borrowers who meet or outperform sustainability targets, are a powerful incentive and can create new business, lower credit risk and support the real economy’s transition to lower-carbon activity.

Banks can also provide retail clients with financial solutions that align them with the need for much smaller environmental footprints. These range from green mortgages and loans for energy efficiency retrofits to helping individual investors to engage with the companies whose shares they own.

The real economy cannot shift fast enough to meet sustainability goals without help from the financial sector. Banks must develop comprehensive strategies and implementation plans. Regulators are likely to force this change — as the UK experience shows.

But the sector should be responsible and act sooner rather than later. It is in its commercial interests to do so.

The writer is director of the Oxford Sustainable Finance Programme at the University of Oxford. This is an abridged version of an essay published by the Social Market Foundation and the Chartered Banker Institute.

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