A new UN-backed methodology to assess climate change risk could help banks better understand the impact of extreme weather on their loan books.
Methodologies published in July in conjunction with the UN Environment Finance Initiative and U.K.-based climate risk modeling firm Acclimatise could, for example, help banks more accurately predict how badly flooding might affect their real estate loans, or how drought may impact farmer borrowers.
But they have their limitations and need to be refined, according to bankers and consultants speaking at an Aug. 14 webinar organized by the UN Environment Program.
Some 16 banks, including Barclays PLC, Royal Bank of Canada and Rabobank, have been piloting two separate methodologies, one for agriculture and energy exposures and the other for real estate lending, both of which are based on scenarios provided by Acclimatise. They are designed to help banks identify how climate change-related risks such as droughts, wildfires and floods might impact their loan books, and to promote transparency around such risks.
The methodologies have been "an important step forward," according to Alexandra Dumitru, an economist at Rabobank. Specifically, it has helped the Dutch bank take a longer-term view of the potential impact of increased flooding on its real estate lending portfolio, she said.
Under worst-case scenarios looking ahead to 2020 and 2040, losses to the property value of Rabobank's portfolio would still remain below 0.3%, according to Dumitru, partly because of the Dutch government's efforts in developing flood protection infrastructure.
Dumitru cautioned that estimates remain "rough" at this stage, and said the banking industry will need to work towards a methodology that is adopted by everyone in order for the benefits to be fully realized.
Other challenges include a lack of readily available "bottom-up" data, such as information from companies about the vulnerability of their operations to extreme weather, Dumitru said in an email.
Ben Walker, head of sustainable development at Australia & New Zealand Banking Group Ltd., which is also in the pilot, said the bank was using the methodology to look at the impact of incremental climate change on defaults in the bank's agricultural lending portfolio.
ANZ has been carrying out stress testing at a portfolio level on its whole agricultural loan book, using Acclimatise's models. Using an assumption about global temperature rises, ANZ estimates that its representative customer revenues would decline by between 6% and 12% in the 2020s.
Farmers in Australia are currently contending with a severe drought.
ANZ's agricultural clients are "masters of adaptation" when it comes to handling extreme heat events, but it is still difficult to say what will happen in the future, Walker said.
"We know that there are some regional locations that will suffer worse than others. The bank is doing more assessment," he said.
Richenda Connell, co-founder of Acclimatise, said during the webinar that banks should be aware that there is often a lag of a year or more between droughts and the first wave of agricultural loan defaults.
Other lenders participating in the pilot are Banco Bilbao Vizcaya Argentaria SA, BNP Paribas SA, Banco Bradesco SA, Citigroup Inc., DNB ASA, Itaú Unibanco Holding SA, National Australia Bank Ltd., Banco Santander SA, Société Générale SA, Standard Chartered PLC, Toronto-Dominion Bank and UBS Group AG.