The US banking sector is far more exposed to the systemic and financial risks of climate change than previously understood by investors or disclosed by banks, according to a report released from the Ceres Accelerator for Sustainable Capital Markets. 

The report, 'Financing a Net-Zero Economy: Measuring and Addressing Climate Risk for Banks', provides an assessment of the loan portfolios of US banks, and finds that more than half of syndicated lending of major US banks is in climate-relevant sectors of the economy and is, therefore, vulnerable to the risks posed by climate change. It finds that banks have an imperative to disclose these risks, which could subject them to major lending losses in the event of a sudden and dramatic change in public, regulatory, or investor sentiment. These losses could send destabilising waves across the economy, the report says.

“Our future depends on banks’ understanding of and disclosure of their exposure to major risks like climate risk.” said Steven M. Rothstein, managing director of the Ceres Accelerator for Sustainable Capital Markets. “The US banking sector’s current lending and disclosure practices are leaving them - and in turn, all of us - dangerously vulnerable to the impacts of climate change. Banks have a strong strategic incentive to better account for, disclose, and mitigate climate risks. While there is growing interest in acting on climate risks from US financial regulators, banks have an opportunity to act on these risks now, without waiting for policy or regulatory change. They can help prevent the next financial crisis, and in so doing improve their competitive position and, ultimately, their financial results.” 

Achieving a full assessment of climate risk

It is widely understood that banks are exposed to both the physical risks associated with climate change and the transition risks caused by the failure to prepare for the associated shift away from fossil fuels. But, as the analysis shows, the current view of transition risk in the banking sector is incomplete, focusing only on banks’ direct loans to the fossil-fuel sector. A full assessment must take into account a bank’s financing of industries that rely heavily on fossil fuels as inputs as well - including agriculture, manufacturing, construction, transportation and the financial sector itself. 

The report finds that each of these sectors is exposed to climate risk, and that the financial sector is particularly exposed, as the interconnected nature of the financial system means that banks could face climate-related losses from interbank lending and even 'fire sales' of distressed high-carbon assets. When taking into account this more complete assessment of climate risk, banking sector losses, as the result of an unplanned climate transition, could be many times higher than current disclosures indicate. 

The report makes 13 recommendations that banks can act on right now to assess and mitigate their exposure to climate risks, including that they:

• Improve their existing climate risk analysis tools and methods.
• Require bank clients to provide more data in key climate-related areas.
• Develop risk management techniques like stress testing and scenario analysis. 
• Build climate risk into day-to-day decision-making tools such as client earnings models. 

Finally, the report recommends that banks act to mitigate their exposure to climate risk by setting and disclosing financing portfolio targets that are aligned with the most ambitious goals of the Paris Climate Agreement, including detailed interim targets and specific timelines for sectoral portfolios to reach net-zero emissions.

Corporate emitters also in the spotlight

The report on bank exposure to climate risk comes after institutional investors issued an urgent call to 47 of the largest US-based corporate greenhouse gas emitters to disclose how their climate lobbying aligns with the most ambitious goals of the Paris Agreement and science-based climate policies. The call to action comes just months ahead of a public benchmark of these companies on their climate actions set to be released early next year.

In letters addressed to the Chief Executive Officers and Chairs of Boards of Directors, the investors specifically warned companies to ensure their climate lobbying is consistent with the 'Investor Expectations on Corporate Lobbying on Climate Change' released last year. The investors urged companies to ensure all lobbying activities - both direct lobbying by the companies and indirect lobbying through their trade associations - are Paris-aligned and to take action when there is misalignment. 

The investors also asked companies to establish strong governance of their climate lobbying activities and provide full public transparency of those activities. The letters advised companies of best practices for corporate climate lobbying provided in resources, including the Ceres Blueprint for Responsible Policy Engagement on Climate Change. The Blueprint highlights that the latest science indicates that limiting global temperature rise to 1.5-degrees Celsius is necessary in order to avoid the most catastrophic outcomes, including climate-driven drought, floods, extreme heat and poverty for millions of people.

“As long-term investors, we need to see our portfolio companies address the financial risks posed by climate change.  We are concerned about the impact of climate change on our investments, as well as its impact on the economy as a whole,” said New York State Comptroller Thomas P. DiNapoli, one of the letter signatories. “In order to assess these risks to our portfolio companies, we need greater transparency and accountability, especially when it comes to lobbying - or supporting trade organisations that are lobbying - against efforts to address this ever-mounting threat."

Investors taking action

Investor signatories of the letters include BNP Paribas Asset Management, Boston Trust Walden, California Public Employees Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS), Mercy Investment Services, New York City Comptroller’s Office, New York State Common Retirement Fund, and Wespath Benefits & Investments. All of the investors are also signatories to Climate Action 100+ and members of the Ceres Investor Network. 

The 47 firms, which span across a range of high-emitting sectors - including oil and gas, electric power, transportation, and food and beverage - are focus companies of Climate Action 100+, the world’s largest investor-led initiative on climate change, with more than US$47 trillion in collective assets under management. 

Earlier this year, all 161 focus companies of the Climate Action 100+, including the 47 notified this month, were informed that they would be benchmarked on their climate progress against a set of key indicators that reflect the goals of the initiative. Paris-aligned corporate lobbying a key indicator in which corporate progress will be assessed. The full assessment - Climate Action 100+ Net- Zero Company Benchmark - is set to be released in early 2021.

Over the past year, growing numbers of investors have asked companies to increase disclosure of direct and indirect lobbying activities. During the 2020 US proxy season, shareholder proposals asking companies to disclose how their climate lobbying aligns with the goals of the Paris Agreement received record high investor support. One resolution, filed by BNP Paribas Asset Management, won a first-ever 53% majority vote at Chevron Corp., including voting support from the largest asset manager - BlackRock. Similar proposals won 46% vote in favour at Delta Air Lines and 31% in favour at United Airlines.  Where investors have not seen progress from company engagements, it is expected that similar resolutions will be filed for the 2021 season.