Lenders and Climate Change: Towards Better Regulatory Management

Article originally published in Mortgage Finance Gazette – 25th July 2022

Lady Barbara Judge, the chair of the Atomic Energy Authority, once said that the three biggest challenges the UK faced as a country are energy security, energy independence and climate change.  That was back in 2010.

If the invasion of Ukraine and the associated geopolitical fallout have taught us anything, it’s that she was right on both the energy security and energy independence fronts.

Given UK Met Office researchers now say there’s around a fifty-fifty chance that the world will warm by more than 1.5C over the next five years – it looks as though she was bang on with climate change, too.  Certainly feels that way as I write this.

Fortunately, for once, it looks as if we might meet the challenge.

It’s a year since the Basel Committee on Banking Supervision (BCBS) released two reports on the challenges banks face in measuring the financial risks associated with climate change.  Climate-related risk drivers and their transmission channels explored how climate-related financial risks arise and affect banks and the banking system. Climate-related financial risks – measurement methodologies provided an overview of conceptual issues related to climate-related financial risk measurement, and described banks’ and supervisors’ current and emerging practices in this area.

It sounds rather technical but, essentially, the two reports concluded climate risk drivers can be captured in traditional financial risk categories.

However, additional work is needed to reliably estimate these risks and connect climate risks to banks’ exposures.  While a range of approaches are currently being used (or are being developed), the process for making estimates is still difficult and demanding.  There are gaps in the data.  The long-term nature and unpredictability of climate change remains uncertain.  As these challenges are addressed, the ability to estimate and effectively mitigate climate-related financial risks will improve.

Building on this analytical work, the BCBS has said it will investigate the extent to which climate-related financial risks can be addressed within the existing Basel Framework, identify potential gaps in the current framework and consider possible measures to address them. And it said it will undertake further work in three broad strands simultaneously spanning regulatory, supervisory and disclosure-related elements for the banking system.

The BCBS is the primary global standard setter for the prudential regulation of banks.  Its 45 members include central banks and bank supervisors from 28 jurisdictions.  Its core activities include exchanging information on developments in the banking sector and financial markets, to help identify current or emerging risks for the global financial system and address regulatory and supervisory gaps that pose risks to financial stability.  It might not be COP26 – but in terms of global banking risk surveillance, this was an important milestone.

And following the publication of those reports, the BCBS has not been idle.  Last November, it said it was assessing and developing a suite of potential measures – spanning disclosure, supervisory and regulatory measures – to address climate-related financial risks to the global banking system.  To that end, the BCBS agreed to consult on a set of principles for the effective management and supervision of climate-related financial risks at internationally active banks.

On disclosure measures, the committee said it is exploring the promotion of a common disclosure baseline for climate-related financial risks. It also agreed to continue to explore the relative merits of potential regulatory measures.  Additionally, the BCBS has held a  public consultation as it promotes a principles-based approach to improving banks’ risk management (and supervisors’ practices) related to climate-related financial risks.

They’re trying to strike a balance: providing a common baseline for internationally active banks and supervisors – while retaining sufficient flexibility given the evolving practices in this area.  It wants to promote a common understanding of expectations, support the development of harmonised practices, and facilitate implementation of the principles as soon as possible.

Over the last 12 months, some banks have worried how Basel will take on climate concerns.  It’s not easy to see how climate stress tests should be handled.  What, in short, should lenders do?

That’s a question we looked to address at our inaugural Climate Change summit. Dr Tyrone Dunbar, Manager of the Urban Climate Services team at the Met Office, offered his view of how climate change will affect our communities and Matthew Jupp, the mortgage policy principal at UK Finance discussed how regulatory compliance is shaping its members’ response.

And we also heard from Rob Stevens, head of property risk at Nationwide on how they were currently screening and thoughts on how they are planning future guidance on forward climate risk. Moving along the stakeholder chain, the key will be how this guidance is aligned between lenders and conveyancers so that the end client is best served through the clearest data and the best due diligence and lending decisions.

It’s only by bringing lenders, valuers, conveyancers, insurers, surveyors, and environmental data providers together that we can hope to successfully develop guidance on dealing with climate change.