The global financial services industry faces $600 billion in climate change risks with widespread implications for banks across credit risk, market risk and operational risk, according to research from by Accenture.
According to the climate disclosures of 45 global financial institutions, the financial impact of climate-related opportunities and risks is estimated to be around US$2 trillion for financial services - US$623 relating to risks, and US $1.27 trillion in potential opportunities, according to the Accenture report, Optimizing the Risk and Return of Climate Change.
The report outlines examples of balance sheet exposure in the banking sector, citing physical risks such as increased flood risk as an impact to banks' mortgage portfolios, severe weather events leading to re-pricing of sovereign debt and impacting business continuity.
The report also cited transition risks including tightening energy efficiency standards impacting on property exposures and stranded assets impairing loan portfolios, tightening climate-related policy resulting in the re-pricing of securities and derivatives, and evolving sentiment on climate change issues resulting in reputational risk exposure.
Many of the financial risks and opportunities associated with climate change are "unlikely to manifest within banks' current financial planning cycle (which is around four years)," Accenture notes. The degree of immediate action is also dependent on a bank's exposure on their balance sheet.
"What appears certain is the growing impact of climate change on banks over time," the report said. "As such, all institutions should have in place an appropriate governance process to approve the inclusion or exclusion of climate risks in their overall risk management framework."
The report recommends four key actions: adjust risk appetite towards climate change, create a climate risk register, conduct framework gap analysis, and quantify and measure climate risk.
In Australia, APRA is developing a framework to assess Australia's largest banks for their vulnerability to climate risk.
APRA is working in partnership with the country's five largest banks to design a climate vulnerability assessment (CVA) which will assess not only their potential exposures to climate risk, but wider vulnerabilities in the financial system and economy at large.
"The purpose here is multi-fold," said Graham Sinden, head of climate risk at APRA, at a panel presentation at the Responsible Investment Association Australasia (RIAA) conference in May. "It's to strengthen the financial sectors' understanding of climate change risk, it's to standardise the sorts of approaches that we use to establish global scenarios, but also to improve the ADI's data collection and to inform risk management, and that's the quantitative aspect of the climate vulnerability assessment."
Accenture advises bank boards to incorporate "climate risks in risk management frameworks, policies and procedures, as well as key management information, to allow for effective monitoring, management and oversight. Senior management roles and responsibilities should be clearly allocated," according to the report.
The global report outlines how regulatory and customer expectations are putting increasing pressure on banks, resulting in the need for improved financial disclosures and a rethinking of banks' approach to risk management. The report strongly references the Task Force on Climate-related Financial Disclosures (TCFD) recommendations.
Currently, all of the big four banks in Australia report using the TCFD framework, which is still a voluntary framework in Australia.
"Climate-related disclosures can be particularly demanding," the report notes. "Past incidences have little predictive power for the future as the changes in climate trends are rarely 'linear.'
"Adding to the challenge, significant disparities can exist between the industry-level impact and that on the individual firms within an industry. Making sense of the potential impact of climate change and forming a strategic response are also difficult due to interconnected global supply chains and a multitude of intersecting legal, regulatory and operating environments."
The report also notes that banks rely on information disclosed by companies, and not all companies have fully reported in alignment with the TCFD recommendations, which would "likely result in incomplete market data across companies, sectors and countries, in turn limiting the ability of banks to fully assess the nature of climate risks on the physical assets they lend against or invest in."