Banks struggle with climate assessment

Despite embedding ESG into risk frameworks, not all banks are considering climate issues in pricing decisions

Nearly two-thirds of global banks are incorporating ESG factors all or “most of the time” into their risk management – but are struggling to assess the financial impacts of climate change, a report reveals.

Fitch Ratings’ report, ‘ Banks’ Risk Management Embraces ESG’, comprised a poll of 182 global banks – with 64% stating they were now embedding ESG into their risk management frameworks ‘always’ or most of the time.

The exception was asset pricing, where only 39% of banks considered ESG risks always or most of the time when making pricing decisions.

Challenges   included   sourcing quantitative company-specific data and how to combine these views with qualitative insights.

In addition, some banks said risk pricing was considered at a business unit level, rather than within their enterprise-risk framework.

However, Fitch said the 39% figure is likely to increase if and when governments introduce financial or regulatory incentives to channel funds into more environmentally sound investments.

The survey, which covered banks in 49 countries, found that ESG emphasis varies by region, with Asia-Pacific and African banks the most likely to take account of ESG in their risk frameworks, while Russian and North American regional banks were among the least likely.

“We expect banks to make greater use of ESG risk data in their risk-management frameworks as the quality of disclosures on corporate sustainability and climate-related risks improves, making it easier to access reliable and comparable data on ESG risks,” Monsur Hussain, head of financial institutions research at Fitch said.

While climate change features in risk frameworks at most of the largest banks – with total assets of more than $500bn – these banks are still struggling to quantify potential financial impacts from climate change, the report added.

“In contrast, we found that assessment of the effect of demographic changes on portfolios is more common at small and medium-sized banks. This could reflect their proportionately greater exposure to demographic changes given their narrower product range and geographical coverage than large international banks,” Hussain commented.

Governance was found to be the most influential ESG factor in banks’ credit ratings, although environmental risk and, to a lesser extent, social risk could play a growing role as governments, financial markets and regulators develop greater focus on them, the credit ratings agency said.

The report sought to assess how banks are placed to meet the climate-related financial risk disclosure recommendations set out by the Task Force on Climate-related Financial Disclosures (TCFD), as well recommendations made by the Network for Greening the Financial System (NGFS), an informal coalition of 34 central banks and supervisors.

One of the Network’s main aims is to strengthen the efforts of the financial sector in achieving the Paris climate agreement goals.

However, according to the report, financial incentives to prioritise sustainable or “green”, assets over less sustainable assets remain underdeveloped.

“Regulators may find it challenging to determine prudential requirements to incentivise “green” assets without compromising on the need for banks to hold capital commensurate with asset risk.

“Authorities may need to balance potentially conflicting incentives if preferential prudential requirements underestimate financial risks, including the credit risk of the asset or exposure,” Hussein explained.