Banking

Heat’s on lenders to reduce climate risk. Big question is how.

Environmentalists have called on banks to disclose the climate risks associated with their lending activities, but the short-term nature of most commercial lending makes it tough to tell what that risk could look like a decade later.

Instead, bankers should examine the entirety of their corporate client relationships and work with those clients now to reduce their long-term risk, a nonprofit focused on corporate sustainability argues in a new report. Bankers should also adopt 10-year time horizons for risk management and 10-year financing plans for each commercial sector, the Boston-based Ceres says.

If bankers approach de-carbonization from a relationship-banking perspective, they have a better chance of holding onto client relationships and capitalizing on new opportunities, the group said.

“These relationships run deeper than any given transaction, both in duration and in value to the bank,” said Dan Saccardi, a senior director at Ceres and one of the authors of the report. “Therefore, it shouldn’t be a decision about any given piece of financing but about the more holistic implications for the bank and for the client about continuing or not continuing to do business together.”

In part because of pressure by environmentally minded activists and investors, some big banks have taken initial steps to mitigate climate risk in their portfolios. Bank of America, TD Bank Group and Morgan Stanley, for example, have announced plans to achieve net zero greenhouse gas emissions from their operations and business activities by 2050 in alignment with the Paris Agreement. And JPMorgan Chase established a Center for Carbon Transition aimed at helping corporate clients adjust their long-term business strategies.

Big banks are making progress at de-risking, but it’s slow. Nearly 15% of shared credit provided by the 12 largest banks in syndicated lending was extended to fossil-fuels companies, according to data in the report covering the years 2000 to 2018. That is down from around 20% during the financial crisis yet still well above 8.6% in 2001.

In October, Ceres released a report suggesting that U.S. banks may be underestimating the climate risk in their lending and investment portfolios. Its new report attempts to establish a road map for banks to deal with transition risk, or the risks resulting from an abrupt transition away from fossil fuels.

As an example, a lender could work with a transportation company now to ensure it can upgrade its fleet to lower-emissions vehicles over the next decade, rather than wait for regulation to nudge the company in that direction.

Some industry voices say many banks are already starting to have those kinds of conversations with corporate clients.

“Companies aren’t going to be able to flip a switch to go from brown to green tomorrow,” said Lauren Anderson, associate general counsel for the Bank Policy Institute, which represents the nation’s largest banks. “It’s going to be a multiyear process, and we would rather see those relationships evolve and be maintained. … I think it’s entirely correct that this has to be looked at holistically.”

Anderson also said that some of the BPI’s members were early adopters of PACTA, an open-source scenario-analysis toolkit that helps banks to understand how closely their portfolios align with the Paris Agreement.

“There’s a lot of work going on here, and while some clients are very sophisticated and having these conversations all the time, it’s obviously a new conversation to other parts of the economy,” she said.

In its recent report, Ceres interviewed about half a dozen bank executives or bank investors. One former banker told the nonprofit that in order for de-carbonization to happen within banks’ portfolios, “it has to be a profit center rather than a cost center for the bank.”

Ceres also quotes Chase Savage, an environmental-social-governance research analyst at Fidelity Investments, who suggested banks could show clients a 10-year financing plan for their sector and ask how they’d like to fit in instead of asking them to work around a list of restrictions.

“The next step is to have a much more in-depth client experience,” Savage said in the report.

Banks might also adjust the pricing of certain products and services to better reflect climate risk, the report said. This can also help corporate clients to make the business case for transition away from fossil fuels. Moreover, bankers could prioritize sectors in which they may have the most valuable relationships or which may need the most time to minimize their environmental impact.

Some big banks have already begun to take those kinds of actions, the group said, quoting one former Goldman Sachs banker who said: “Fossil-fuel valuations have collapsed already. … The [leading] banks see what’s going on. … They are not looking back, they’re looking forward.”


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