Climate risk accounting is coming to bank balance sheets. The process has been slow but steady, with large banks already adopting methodologies for recognizing the cost of climate change in discrete areas like lending and investment banking. There are also regulatory calls for modeling the impact of large-scale or sub-systemic shocks to asset prices.
In late 2020, we have a few certainties: death, taxes and now climate risk. The global consensus has shifted to understand that heat waves, droughts and wildfires will be part of the new normal. Institutional and retail investors are starting to appreciate this fact as well, and green bonds and Environmental, Social and Governance (ESG) products have outperformed their traditional peers in the market. The concept of climate impact to the wellbeing of corporations is in the public consciousness.
As an upcoming step, bank risk capital ratios will begin to incorporate the cost of climate change. This will impact the RWA of assets for Basel ratios and the cost of collateralized products and OTC derivatives. Competing methodologies for these types of calculations are already in the market. As thinking about climate change risk matures, investors and intermediaries should expect changes to the pricing and terms of their financial transactions.
The next phases of climate risk scenario planning and accounting will be more direct, intense, and will reverberate throughout financial markets. As banks undergo stress tests that look at the value of assets in an extreme climate event, or even a gradual but sustained climate event, they and the public will recognize the potential impact to profitability and broader financial stability. This in turn may force a reconsideration of the value of those assets before an extreme event occurs simply by considering the likelihood of the event itself. Some variation of a climate-related Value-at-Risk (VaR) calculation is probable.
This report assists market practitioners in thinking through the practical implications to their own firms of climate risk accounting on bank balance sheets. The report includes a review of leading methodologies for analysis and looks at how, exactly, they will attach a cost to assets. The report concludes with an analysis of how market participants should think to position themselves now in response to new changes.
This report should be read by any market participant in businesses that use bank balance sheets, including Treasury, OTC and listed derivatives, securities finance, repo and clearing. The report should also be useful to service providers and regulators to these operating activities.
A direct link to the report for Finadium research clients is https://finadium.com/finadium-report-desc/climate-risk-analysis-for-treasury-and-collateral-managers/
For non-subscribers, more information is available here.