Banks Should Adapt Lending Strategies to Account for Increasing Physical Risks of Climate Change, Finds Bain & Company and Jupiter Intelligence
Climate change is becoming increasingly significant and materializing quickly; banks need to start monitoring and mitigating exposures to avoid being blind sighted in the future.
Analysis shows mortgage portfolios could be hit by 10-15% in terms of collateral value.
Physical perils projected to increase markedly at global level, with different intensity and speed of impact across all countries
Camille Goossens, senior partner at Bain & Company and leader of the firm’s Sustainability and Responsibility Financial Services practice
A minority of banks worldwide account for climate change-related physical risks in their mortgage lending strategies, finds a benchmark conducted by Bain & Company on the 50 largest banks globally, by total assets, which currently adhere to the Financial Stability Board’s Task Force on Climate-Related Financial Disclosure1.
An analysis of European banks found that just 18% have begun to integrate physical risks into their mortgage lending strategies. However, the vast majority of European banks are yet to incorporate physical risks into their strategy definition, monitoring processes, target setting, product offering or client engagement.
A global physical risk impact analysis, conducted by Bain & Company and Jupiter Intelligence, shines light on the dangers for banks, and financial institutions more broadly, of failing to properly account for climate change. The study reveals the increasing amount land across the globe that is projected to become subject to physical risk perils1.
In the United States, 43% of land is currently subject to physical perils, a figure projected to reach 65% by 2050. In Indonesia, 31% of land is currently deemed at risk; that figure is projected to increase to 97% by 2050. European countries show similar patterns over the same period. Germany’s surface at risk is expected to increase from 33% to 68%, and Italy’s from 40% and 62%2.
Bain and Jupiter simulated financial implications for a model bank, with an Italian-located portfolio, revealing the impact these changes could have on the value of banks’ assets and profitability. Without any mitigating actions, by 2050 the value of the model banks’ mortgage collateral could fall by as much as 10-15%. This in turn could hit the profitability of those banks’ mortgage lending by 7-10%.
Camille Goossens, senior partner at Bain & Company and leader of the firm’s Sustainability and Responsibility Financial Services practice, comments: “Climate change will have a profound impact on property across the globe, and no market is immune to this. Currently, banks’ strategies for addressing their exposure to climate change are far too limited.”
“Many banks are aware that they face considerable exposure to climate change-related risks but have not yet made the changes required to adapt their business strategies to mitigate these future risks. Without a comprehensive approach to dealing with the risks in their portfolios, they could find themselves very substantially compromised.”
Offense or defense? How banks should respond to the threat to mortgage portfolios
Bain’s report lays out how banks can implement strategies to not only limit the effects of climate change, but even improve overall profitability, through a combination of defensive tactics, offensive tactics and new offerings.
Potential defensive tactics include imposing loan-to-value caps and reducing the cost of risk through credit protection insurance. A more offensive approach could include raising discount levels on low-risk assets or deploying standalone climate risk protection insurance. Such actions should not be pushed to the limit as this may create counterproductive outcomes, especially early on when market is adapting to new phenomena.
Finally, the report recommends that banks develop new offerings to help clients mitigate the impact of climate change. These include financing climate adaptation solutions and offering assessments of the physical risk resilience of corporate assets and facilities.
The analysis reveals that combining mitigation measures with value creation moves could yield a 15- to 20-percentage-point increase in banks’ net operating income in 2030.
In order to be prepared in the future, even as a fast follower, banks need to act now by gaining transparency and understanding of their portfolio exposure to then start building their strategy.
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