siliconindia | | DECEMBER 202119In November last year, a couple of weeks after he became President-elect, Biden appointed the first ever climate envoy, John Kerry. Then in May, he issued an executive order for the Financial Stability Oversight Council (FSOC), instructing that a comprehensive government-wide climate-risk strategy be developed within 120 days to pinpoint and dis-close climate-related risks to govern-ment programs, assets and liabilities, highlighting a clear centralised coor-dination that will impact future regu-lation.Turning to banks and the chal-lenges and opportunities they're fac-ing when it comes to climate change risk management, at OakNorth, we've identified several of these:DATA & SCENARIO ANALYSISBanks need very granular data to examine effects at the counterparty and exposure level. This is because climate risks are highly uncertain and non-linear in their propagation and can affect multiple risk catego-ries simultaneously. Banks therefore need to consider a broad range of sce-narios and with sufficient granularity to enable them to adequately assess the risks of meeting their risk man-agement objectives and wider climate change targets.PREDICTING FUTURE RISK OVER VERY LONG-TERM HORIZONSHistorical loss experience cannot be used to estimate the future risks. For one thing, the scale of natural disas-ters can vary significantly ­ an earth-quake that scores 3.0 on the Richter Scale for example, has ten times the amplitude of one that scores 2.0, so will likely cause a lot more damage. Equally, the response from local gov-ernment and emergency services to manage the consequences of events such as an earthquake may vary sig-nificantly from state to state. Climate risks are expected to materialise over a long-term horizon, so regulators and boards will expect management teams to be able to model different scenarios based on this. This presents a challenge however, as banks are typically used to looking at potential risk over 9-12 quarters, not decades.REPUTATION & DUE DILIGENCEPublic opinion is critical in terms of how a bank is perceived in its com-munity, so senior management and boards need to look at the existing risks in their portfolio and what types of risks they're willing to take on in the future. Banks are expected to do significant due diligence on who they lend to and how they lend to them. Regulators want to see banks exam-ining their entire portfolio to identify the most vulnerable borrowers with regards to climate change, and work with those borrowers sooner rather than later to reduce their long-term risk. While this creates challenges, it also creates opportunities for banks to identify clients that will have to go through a transition period, and seeing how they can provide advice, funding, and services that may facili-tate that transition.PROPORTIONALITYThere is uncertainty about the appro-priate governance structures required for different sized firms, and the level of detail needed to meet disclosure standards effectively, given that pro-portionality is something regulators are still thinking through. Having said that, smaller banks tend to have more of limited geographic footprint, and therefore in certain geographic areas, it's going to be more important that sea levels are rising than it will be in other areas. This means banks need to know about both their geographic and sectoral exposures at a granular level.EXPERTISE & CORPORATE GOVERNANCEThere is a lack of expertise and un-derstanding on climate risk across the banking industry at all levels of seniority, as the mix of skills, knowl-edge and experience required is new and complex.Looking ahead, climate change is an area where executive manage-ment and the board of directors at banks need to take a very active role in setting the direction of travel. In-stitutions are going to differ in terms of their strategy, client selection, and risk appetite, and there are sig-nificant challenges that need to be addressed. However, for banks that are willing to be proactive, climate change presents an opportunity to support customers through the tran-sition to greener operations. This in turn, will create positive ripple ef-fects across its stakeholders ­ from investors to employees, customers to regulators. There is a lack of expertise and understanding on climate risk across the banking industry at all levels of seniority, as the mix of skills, knowledge and experience required is new and complex
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