Top 10 Take-aways from Climate Change Risks, Regulations, and Rewards


April 1, 2022

Discover the key take-aways from our recent webinar with three ex-regulators: Mark Levonian (former Senior Deputy Comptroller of Economics at the OCC), Bruce Richards (former Senior Vice President and Head of Supervision for Complex Financial Institutions at the Federal Reserve Bank of New York), and Jeremiah Norton (former Board Member at the FDIC). The discussion was moderated by Nick Lee, Head of Regulatory and Government Affairs at OakNorth and an ex-regulator himself, having spent over two decades at the Bank of England overseeing the authorization and supervision of all new UK banks. 

Missed the webinar? View the recording here.

1. The data dilemma

Data is one of the challenges we hear most often when it comes to climate change risk – banks either have too much data which creates challenges around variety, velocity, veracity, and volume, or too little. Mark noted that: “firms need to be taking the necessary steps to get more granular data, get it in a more standardized way, and figure out what data is needed from borrowers and counterparties.”

2. Physical vs transition risk

There seems to be agreement across the industry that physical risk is easier to measure because of the number of extreme weather events that have occurred in recent years and that firms must deal with these issues through business continuity or other resiliency planning frameworks. However, transition risk is much harder to grasp as there are so many variables at play: what will happen in the future? What policy changes will there be? How will consumer preferences change? What technologies will disrupt the sector? Jeremiah explained: “all these things will factor into how the transition plays out, so modeling that and understanding that in a framework is essential.”

3. The consistency conundrum

Many banks are already voluntarily recording different aspects of climate risk and exposure for themselves and their customers. However, there’s currently very little consistency – some are following the Taskforce on Climate Related Disclosures, some are following the Global Reporting Initiative, some are following the Sustainability Accounting Standards Board, etc. Bruce reminded the audience of recent remarks from SEC chair, Gary Gensler, on how “there's an efficiency that comes from standardization” – a statement he said he wholeheartedly agrees with. Jeremiah noted that agencies are keen to understand the challenges that banks face and their approaches to climate change measurement, so it can be helpful in some cases for banks to commit to disclosing targets under various industry groups.

4. Greatness in granularity

As touched on earlier, many banks are working to put together better, more granular data, and there’s a recognition in the industry that the effects of climate change can be highly localized. Mark said banks, therefore, need to be looking at both geographical granularities as well as industry sector granularity. Bruce illustrated this point with an example in the US car industry where there are approx. 20,000 new car dealerships, 150,000 used car dealers, and 250,000 auto repair and maintenance centers. All these businesses are being impacted by increasing demand for electric vehicles which require far less maintenance than an internal combustion engine and have far fewer moving parts. This is why Bruce said institutions “need bankers and risk managers who can think ahead and take a forward-look view of the impacts their borrowers may be facing, as well as climate confident relationship managers who know how to talk about these challenges with customers.” It’s critical that banks truly understand at the loan level what risks they’re taking on to their balance sheet on behalf of their borrowers.

5. Creating a strong risk framework

To effectively manage climate change risk, banks will need to develop a framework that incorporates governance, people, process, and policies. Fortunately, there’s an existing framework within most institutions to deal with risk – first, second and third line – so the key lies in incorporating new risk appetites and ways of working into it. The first line needs to understand the risk appetite the bank is operating under, and how to translate that into helping borrowers that may need to transition their business operations. However, as Jeremiah explained: “these efforts don’t stop at the first line – the second line will need to work with the Board and senior management to develop that risk appetite, and the third line will need to think about how it will audit the framework.” There are areas such as capital planning, resolution planning, liquidity planning, etc. where lessons can be applied to how banks approach this particular area.

6. Too many cooks in the kitchen

A challenge that’s unfolding within many banks is that there tend to be many different internal stakeholders involved – from the Board to senior management, risk to credit, ESG to PR, etc. This can be incredibly challenging as different teams will have different priorities and processes. Some may be more interested in the growth opportunity in the loan book, while others may be more concerned with the risk it presents. Some may wish to stop lending to certain sectors which are seen to be more polluting, while others will want to slowly move away from these. Bruce said that “it’s essential that the tone is set from the top – both from Board and senior management – and that the philosophy, strategy, and risk appetite is communicated down the organization in a consistent way.”

7. Synchronization or silos?

Some banks are choosing to incorporate climate risks into the traditional areas of risk – market, operational, credit, and reputational risk. Bruce referred to a bank he’s seen incorporating climate change risk into each of the existing risk streams, but then also having a central office that is forward-looking and provides input to the different risk streams and the front line.

8. Guidance will likely be inter-agency

There was agreement among the panelists that while agencies are currently pursuing separate but related streams of work – the Fed and the OCC are consulting on draft principles on climate risk for large banks, while the SEC has proposed rule changes around climate-related disclosures – future guidance is likely to be inter-agency. As Jeremiah said: “Notwithstanding discussions about energy and nomination battles, the administration is going to continue its initiative to enhance the management of disclosures and supervision on climate risk. The people running the agencies now have a fairly aggressive view about what supervisors should do for climate risks and/or for carbon reduction.”

9. Banks should pre-empt policy

Many institutions can be reluctant to get too far out in front of where regulatory expectations are going, but there’s much that can be done in the interim that doesn’t require waiting for regulation – methods, governance, thinking about the impact on strategy, etc. While larger banks will be impacted first given their systemic importance, agencies have made it clear that guidance will flow down to regional and community banks in the coming years, so they should use this time wisely. Mark made the point that smaller banks that have a more limited geographical footprint and / or some form of industry concentration will be more vulnerable to climate effects. As such, climate change represents an existential threat for some if they don’t take the necessary steps now to get it right.

10. Barring brown borrowers?

While there are past examples of agencies putting formal limits on concentrations in specific sectors such as commercial real estate, there is no precedent in terms of requiring higher capital for particular industries, or restrictions on lending volume, etc. It’s unlikely, therefore, that there would ever be formal restrictions barring “brown” borrowers. Jeremiah said: “examiners are pragmatic – I would expect them to be reasonable and respond well to firms that have thoughtful approaches to climate risk management and to frameworks that help clients transition in measured and managed ways.” However, as Mark noted, that’s not necessarily the most important impact the supervisors have in the US system: “a lot of influence comes through the examination process. Examiners exert influence on lending in a lot of subtle, nuanced ways, such as the raise of an eyebrow in connection with a particular portfolio.”

The discussion concluded with agreement from our panelists that while there are numerous challenges to overcome, the financing opportunity presented by climate change is enormous, and that it also presents a significant opportunity for banks to build strong, long-lasting relationships with customers. If a bank is on the front foot, talking to customers about the challenges they face, helping them solve those, and providing some long-term perspectives, they’ll build consultative relationships that will far outlast any significant loan term.

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