Climate change can affect the financial health of borrowers and pose a credit risk in banks’ loan portfolios. This can have a knock-on effect for the financial system, and us.
Five South African banks have a combined asset value of over R6.8 billion. Bank assets a funded by our deposits and investments, and some of those assets may be at risk if they are invested in highly exposed sectors. Without disclosure of the concentration of assets in carbon related sectors, we are not aware of the extent of their risks.
Banks need to assess the extent of their exposure to climate-related risk and implement mitigation strategies to ensure the long-term stability of the financial services sector. Despite the need to strengthen governance and risk management practices following the 2008 financial crises, only Nedbank reports on the concentration of carbon assets in its portfolio of the five banks assessed in Full Disclosure 5.
Carbon-related assets place us at risk.
You contribute to a bank’s funds through deposits into your bank account. The money you deposit in the bank is pooled, and the bank may use that money to provide to its other clients or invest.
Our pensions and investments
You may contribute money to a pension fund or place your investments with an asset manager. Your pension fund or asset manager may invest your funds in one of South Africa’s banks.
Banks provide finance, loans, and equity investments to companies from which they earn interest and fees. This includes finance and services to high greenhouse gas emitting companies, which form part of a bank’s corporate loan portfolio.
The banks assessed in Full Disclosure 5 provide a number of solutions to corporate clients. Corporate banking services typically include:
- Corporate and transactional banking
- Providing loans and working capital requirements
- Financing commercial and industrial property development
- Investing in projects and infrastructure (through debt or equity)
Banks may provide financing, loans, or other financial services to companies that emit high amounts of greenhouse gases. Banks have, for example, provided funding to independent power producers who generate electricity to sell to Eskom.
A lack of information places banks at risk.
Banks need to assess the extent of their exposure to climate-related risks in their corporate and wholesale loan portfolios. A catastrophic climate-related event (physical risk), or unexpectedly rapid decline in commodity prices (transitional risk) that affects borrowers’ ability to repay the bank could potentially lead to bank failure depending on the extent of the bank’s exposure to affected sectors.
Companies that emit high amounts of greenhouse gases face physical and transitional risks as a result of their emissions. These risks are passed on to the bank: if emitters are unable to repay their debts to the bank, the emitters could default on their loans, placing banks’ corporate and wholesale loan portfolios at risk.
The TCFD Recommendations can help banks understand their risks
Voluntary disclosures under the TCFD Recommendations encourage banks to assess the concentration of carbon-related assets in their portfolios and to take steps to reduce risk exposure by implementing strategies to maintain operations and profitability while safeguarding people, assets, and reputation. Banks are better able to assess the risks if they are aware of the risks of their borrowers.
Understand risks through borrowers’ disclosures
Banks that are aware of the extent of exposure to risk and adapt their businesses to avoid impact are more resilient.
Banks should require clients in high-risk sectors to report on their own strategies to reduce the impacts of climate change under the TCFD, as a prerequisite to extending credit. This will enable banks to assess the extent of their exposure to carbon-related assets, and to take steps to mitigate exposure.
Mitigate the risks of high concentration of carbon-assets in loan portfolios and ensure resilience
Banks should disclose how they will change their business strategies to mitigate physical and transitional risks that affect their borrowers.
Once banks are aware of the concentration of carbon-related assets in their portfolios, and have assessed the extent of risk to borrowers, banks should use scenario analysis to set strategies to mitigate the impacts of a low carbon transition on the bank’s activities.
A lack of strategy places our funds at risk.
Climate change is not just an ESG issue, it is a financial issue. Transparent reporting which encourages good corporate governance and risk management practices can ensure that the banking sector avoids another global financial crisis.
The 2008 global financial crisis was sparked by a collapse of US banks which had provided loans to people who had difficulty repaying. A similar crisis could occur in, what is referred to by economists and the financial sector as, climate’s “Minsky moment”. According to UNCTAD’s Trade and Development Report 2019, “if financial portfolios are not aligned with climate policies, there could be a “climate Minsky moment” where a rapid system-wide adjustment to climate change threatened financial stability, in addition to wider impacts on productivity and growth.”
The TCFD Recommendations can help us make wiser decisions
Voluntary disclosures under the TCFD Recommendations allow institutional investors, such as pension funds, to price in the risk of investing in banks that have high concentrations of carbon-related assets. It also allows banking clients to make a conscious choice about where to place their money.
Reducing exposure to long-term physical and transitional risks enables long-term trust
Although corporate loan portfolios tend to be short term, a bank that discloses a strategy for reducing exposure to transitional and physical risks demonstrates that it has a decades-long commitment to ensure its stability.
Enable institutional investors to price in risk and clients to make more informed decisions
Banks should publicly disclose the concentrations of credit exposure to carbon-related assets or the amount and percentage of carbon-related assets relative to their total assets, in line with the TCFD Supplemental Guide. Out of the five banks assessed in Full Disclosure 5, only Nedbank reports on the concentration of credit exposure to carbon related assets.