Climate Risk and Financial Resilience: Harnessing Fintech to Build Sustainable Lending Practices
Yugal YadavMay 31, 2023
Businesses of all sizes across the globe are facing an increasing level of climate-related risks from a growing number of extreme weather events, including floods, forest fires, and cyclones. A worldwide study published by the Yale School of the Environment found that between 1980 and 1999, there were 4,212 natural disasters, claiming 1.19 million lives and causing $1.63 trillion in economic losses. However more recently between 2000 and 2019, these figures rose significantly to 7,348 major natural disasters, resulting in 1.23 million fatalities and $2.97 trillion in global economic losses.
As these extreme weather events continue to become more frequent over time, synergies between climate risk and financial resilience also appear in sharper focus. These climate-related financial risks, including both physical and transition dangers, have the potential to dramatically impact a bank’s loan book and overall performance, whilst also affecting several key sectors of the economy. Therefore, lenders should implement their own best practices when it comes to climate risk assessment, management, and monitoring. A few best practices are outlined below:
- Establish a dedicated climate risk management framework: Banks should develop a comprehensive framework that integrates climate risk assessment into their overall risk management strategy. Framework should also clearly define governance structures, roles, and responsibilities. In addition, climate risks should be consistently evaluated alongside banks’ other financial risks. By incorporating climate data into risk models, banks can enhance their ability to assess, monitor, and mitigate climate-related risks effectively.
- Enhance data and scenario analysis use: Lenders should utilize data-driven scenario analysis to evaluate the potential impact of different climate outcomes on their portfolios and operations. By leveraging climate models and scenario datasets, banks can simulate the financial implications of various climate outcomes and assess their exposure to transition risks.
- Monitor and build resilience: Banks should regularly monitor and review climate risks and their management strategies. In addition, it is imperative for them to stay informed about evolving climate science, policy developments, and emerging risks to remain adaptive and proactive. Stress tests that submit portfolios to multiple climate scenarios should be done to evaluate resilience to climate-related shocks.
It has therefore become imperative for financial institutions to continuously evaluate and refine approaches as new information and data sets become available, and the understanding of climate change evolves. However, regulators have repeatedly emphasized that the tools currently available to banks are insufficient for a thorough evaluation of climate-related risks. Fintechs are filling this gap by using advanced data analytics, AI, and machine learning, as well as leveraging comprehensive traditional as well as alternative climate-related datasets, thereby improving the precision and granularity of climate risk assessments. By leveraging fintech solutions, banks can strengthen their understanding of climate risks, improve risk management strategies, and align their business practices with sustainable principles. Consequently, lenders are constantly deciding between Buy, Build, or Partner when it comes to strengthening their financial resilience and managing all aspects of climate change risk.
One example is our ON Climate solution which is enabling some of the leading US lenders to address the growing regulatory demand to evaluate, measure, and report on climate-related risks and financed emissions. OakNorth Credit Intelligence's (ONci) climate scenarios are built to stress test portfolios at different time intervals, including policy target term, to enable banks to assess how their portfolio would perform across different time periods, and to determine the right mix of borrower profiles as per their strategic risk objectives. These scenarios can be applied at the borrower level across the loan book, thus enabling banks to perform a bottom-up portfolio impact assessment of transition risks and providing them with immediate and actionable intelligence to shape their loan exposure to be more resilient.
Applying ONci's climate scenarios on their loan books enables lenders to comprehend the risks that could manifest under various climate change scenarios. ONci climate solutions provide powerful insights that enable banks and financial institutions to get ahead of climate-related risks and opportunities in a data-driven manner, enabling smarter, faster, and more proactive decisions across the credit lifecycle.