Moody’s: Climate change to force banks to transform

Carbon transition and physical climate risks are pushing banks to alter the cost-benefit analysis of their lending and investment options


THE global banking sector is under growing pressure to transform its business model as governments move towards low-carbon economic models as physical climate risks become more acute.

Moody’s Investors Service Ltd senior credit officer VP Alberto Postigo, in a report yesterday, stated that carbon transition and physical climate risks are pushing banks to alter the cost-benefit analysis of their lending and investment options.

“This requires the industry to integrate climate risk considerations into its strategic decisions, business processes, governance and risk management frameworks. Banks also have to accommodate stakeholder demand for better climate-related financial disclosures,” he said.

Postigo said climate change mitigation and adaptation will also require a major reallocation of investments, forcing banks to rebalance their loan and investment portfolios.

He said some assets and investments will become “stranded” — effectively non-viable due to technological, market or regulatory changes — while others will depreciate in value or become less profitable.

“Investments in less carbon-intensive sectors or climate-resilient infrastructure, will have strong growth prospects,” he noted.

Banks’ lending exposure to climate change varies by business model and geography, but it can materially influence the credit quality of large sections of their loan books, Postigo added.

A study to approximate bank exposure to climate risk by looking at the sectoral breakdown of their loan books that was carried out by the European Banking Authority

in 2020 with a sample of 29 volunteer banks found 55% of the banks’ corporate loans were allocated to sectors potentially affected by transition risk, with five sectors — manufacturing, electricity, construction, transport and storage and real estate — accounting for 87% of the banks’ total carbon-sensitive exposures.

“The results are likely representative of the European Union (EU) banking system as a whole, as the participating banks accounted for a combined 42% of EU banks’ total corporate exposure,” the report read.

Many large banking groups have started to incorporate climate factors into their strategic plans and operations, while simultaneously improving their management and disclosure of climate risks.

Most of these banks participate in international forums and organisations created to enhance the understanding, management and modelling of climate risks.

“Large banks’ head start partly reflects their bigger investment capacity. However, these banks also face greater pressure from stakeholders to lead by example, given the far-reaching impact of their business decisions.

“Lacking the same investment capacity, we expect small and medium-sized banks to leverage work done by larger peers, regulators and international organisations,” the report stated.

Similarly, climate change will also affect borrowers’ finances and thus creating credit risks for banks.

The rating agency expects banks to gradually become better at managing and pricing climate risks.

“A sudden and disorderly carbon transition could trigger a widespread reappraisal of asset values, and the creditworthiness of some bank borrowers.

“Credit risks for banks would increase in such scenarios, requiring the industry to adjust more rapidly. Whether the transition is gradual or disorderly, banks that fail to adapt are more likely to incur credit losses,” it noted.