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Amid investor scrutiny, Norway's banks future-proof against climate risk


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Amid investor scrutiny, Norway's banks future-proof against climate risk

Norway's central bank has warned that climate-related risk could entail substantial losses, reputational damage and financing problems for the country's banks, but analysts are confident the Norwegian banking sector will be able to future-proof itself.

Norges Bank released in November its Financial Stability Report 2019, in which a chapter dedicated to climate risk highlighted Norway's oil and gas industry as the main source of so-called transition risk.

As opposed to physical risks — linked to climate change such as temperature increases and extreme weather — transition risk comes from changes to consumer and investor demands, shifts in climate regulation and competition.

This could cause problems for banks in the carbon-intensive country, and not just for those lending to oil and gas companies. A structural decline in oil-related activity would spill over into other sectors of the economy, such a property, agriculture and fisheries, which the central bank said could mean "large losses" for lenders.

The changing sentiment around sustainability was apparent as DNB ASA, Norway's biggest bank, gathered investors for its capital markets day Nov. 20.

"We recognize, and we experience first-hand, investors' growing concern related to ESG issues," said Harald Serck-Hanssen, head of corporate banking.

Long-term, manageable risk

Despite growing regulatory and investor scrutiny, experts are not overly concerned about Norwegian banks' exposure to climate risks, at least not for now.

Currently, Norwegian oil and gas companies are more vulnerable to changes in the oil price than climate risk, said Karin S. Thorburn, research chair professor of finance at the Norwegian School of Economics, in an interview. This is typically priced into loans they receive, she said.

In the short term there's "a huge cash flow" to the oil and gas sector, she said, adding that the recent IPO of Saudi Arabia's state oil company illustrates the high level of interest in funding the sector and a belief in continued demand for oil and gas products.

"When it comes to the oil and gas sector, the transition process is going to be very long-term," she said. "We're talking decades. So there is time for the banks to mitigate the individual exposures they have to this sector."

While the timeline for such transition could be long, corporate loans are usually short term, said Pauline Lambert, executive director for financial institutions ratings at Scope Ratings.

"Five to seven years would be a typical corporate loan. So there is time for banks to manage the exposures and the risks," she said.

Research released by Moody's in September 2018, which assessed the environmental risk exposure of 84 industry sectors, also rated the risk for banks and finance companies as low. It said environmental risks to banks, which is typically indirect through financing clients' operations, is "unlikely to translate into meaningful credit impact."

"This is obviously a long-term risk that the banks will have to be aware of, but it's not an imminent risk; at this point in time [it is] manageable," Nondas Nicolaides, senior credit officer, financial institutions at Moody's, said in an interview.

Steps to diversify

Nicolaides credited Norwegian banks for taking steps to future-proof their loan books and incorporate climate risks into their assessments.

A total of six Norwegian banks — DNB, SpareBank 1 SR-Bank ASA, SpareBank 1 SMN, SpareBank 1 Østlandet, Fana Sparebank and KLP Banken AS — have signed up to the UN Principles for Responsible Banking, which aim to encourage banks to bring their strategies in line with global warming targets.

The banks have generally been scaling down their lending to oil and gas companies, a move that was driven in part by the oil price downturn in 2014 to 2015.

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DNB has reduced its oil-related exposure by 40% since 2015. It has also shortened the duration of its corporate loans to three to five years on average, said Kaj-Martin Georgsen, head of corporate responsibility at DNB, in an interview.

Furthermore, the bank is more critical in assessing the oil and gas companies it supports, expecting them to have a "resilient strategy to meet the low-carbon future," he said.

Norwegian banks have also started to tap the green bond market. In the first nine months of 2019, DNB arranged sustainable bond volumes totaling €3.3 billion. In September, Sparebank 1 SMN issued its first green bond designed to encourage sustainable fishing practices. SpareBank 1 SR-Bank followed with its first green bond in October.

Furthermore, Nicolaides has seen a growing number of Norwegian banks obtaining an ESG rating from external agencies, which he said is "very encouraging" because it shows they want to be monitored and assessed on this type of risk.

Transition risk will vary for Norwegian banks, Nicolaides added. A bank such as DNB is diversified geographically, whereas regional savings banks such as SpareBank 1 SR-Bank, based in Stavanger, and Sparebank 1 SMN, based in Trøndelag, could be more vulnerable to climate risk because they operate in regions with high oil and gas activity, he said.

The regional differences mean banks may take different approaches to the challenge ahead.

"Especially if you're a regional bank and you're in an oil-exposed market, it's difficult to suddenly exclude all of these customers from your loan portfolio, but there are opportunities to help them transition or restructure to deal with things that are coming in their industry," said Lambert.