Climate Risk: Who Cares?

Collier Wright

November 15, 2023

Previously we explored the relationship between climate risk and credit risk. Given this close association, it should come as no surprise that there are many stakeholders both inside and outside the bank that care about climate risk management. Understanding who those stakeholders are, and why climate risk matters to them, will help your bank build and maintain a successful climate risk management framework.

Enterprise and Climate Risk 

As with any regulatory concern, enterprise risk will ensure that regulatory reporting is accurate, timely, and compliant. They will also be concerned with a broader view of the impact of climate risk on other bank risks, including operational, market, liquidity, legal, reputation, etc., and with the internal coherence of the bank’s climate strategy assumptions across ESG, risk, and operations. 

The climate risk team is often responsible for evaluating and providing the data and tools the various teams across the bank will require to plan for climate risk. Because climate risk teams will ultimately be successful when climate risk is adopted throughout the bank, it is especially important that they understand the priorities and requirements of other departments when doing this evaluation. Additionally, they will play a key role in educating other departments on how to incorporate climate-specific data and tools into existing frameworks and capabilities. 

Second-Line Credit 

The portfolio risk team is already responsible for scenario analysis, stress testing, and loss modeling, and many are interested in exploring climate risk as an additional element. However, they often realize that existing data and models are insufficient for their needs. They will need to work closely with the climate risk team to translate climate metrics into portfolio risk metrics. Ultimately the goal is to embed this analysis into existing portfolio management as ‘just another scenario.’ In other words, how will transition and physical risk affect the bank’s expected credit loss under various scenarios, and how should those scenarios be weighted relative to other stress testing exercises performed at the bank?  

First-Line Credit and Lending 

We explored in a previous article the ways in which climate risk manifests as credit risk. Just as regulators and examiners expect the front line to own credit risk today, they will expect the front line to own climate risk in the future. Credit and lending should focus on the data they need from borrowers to accurately assess financial health now and in the future, the extent to which that data differs from what’s already collected, how that needs to be incorporated into ratings frameworks, and what the appropriate sensitivity analysis looks like. They should also consider how they can differentiate their services by helping borrowers navigate this emerging risk to the business, and how to identify new lending opportunities. 

Finance and Investor Relations 

This team’s immediate concern will be the impact of both climate risks and opportunities on the bank’s earnings models. Additionally, the SEC will likely require investor disclosures on carbon emissions and climate risk in the near future. Finance and IR need to be prepared to answer, or find answers to, investor questions. As such, it will be important to them that the strategy is coherent, and the assumptions are internally consistent. 

Environmental, Social, and Governance (ESG) 

ESG teams are primarily focused on the emissions profile of the bank, public commitments the bank has made to external stakeholders, and what a path to achieving those objectives looks like. They are also often responsible for the governance; in other words, who will own the strategy, how performance will be measured, and how results will be reported. They will work hand in hand with climate risk and investor relations to ensure that assumptions and reports are consistent across the organization. 

Infrastructure and Technology 

Assessing climate impact requires new data and tools. This team will need to prioritize project resources to evaluate and implement these new tools. Since many banks will already have significant data modernization programs underway, understanding how climate data fits into that structure is important (where does the data come from, who needs it, and how does it need to be served?).  

There are three reasons it is important to understand the lens through which each department is viewing climate risk, and how to bring them into alignment: efficiency, consistency in reporting, and consistency between strategy and execution. For example, the ESG team may begin with an emissions calculation, enterprise risk with a sector heat map, and the second line with a framework for industry transition risk. Emissions calculations and sector outlook are both inputs to a transition risk framework, but if these departments are not communicating there is risk of doing double or triple work. 

And that is if each team uses the same assumptions and arrives at the same conclusions. However, because different teams have different motivations and goals, there is risk that they will use different assumptions and arrive at inconsistent conclusions. If there is no communication between ESG and second line credit, for example, the bank may end up reporting financed emissions numbers to investors that are inconsistent with the emissions assumptions in the transition risk model shown to examiners. This will put the investor relations and enterprise risk teams in an awkward position communicating with external stakeholders. 

Finally, there is value in having a connection between strategy and execution. For instance, the second- and first-line credit teams working together are more likely to report accurate transition risk numbers and to identify and capitalize on transition opportunities by starting with a framework that can incorporate both top-down assumptions and bottom-up refinement. Working separately, teams are more likely to build incompatible frameworks that result in missed risks and opportunities. 

About the author

Collier Wright

Sales & Customer Success at ONci