Banking On Granularity To Reduce Climate Blindspots
By Dharisha Mirando 18 February, 2019
Climate & water risks are financially material for banks but they have not started to map their assets. CWR's Mirando expands
Water risks are financially material because without water our economies would not be able to function.
The potential for water to impact a bank’s balance sheet & performance is being overlooked
This is not a revolutionary new concept; we have been talking about it for years. But financial institutions have been dragging their feet to incorporate these risks into the investment process. Instead, water has been a CSR focus, with millions being spent every year. This has significant societal benefits but the potential for water to fundamentally impact a bank’s balance sheet and performance is being overlooked. Thus the interests of shareholders and savers are being ignored.
Focus has been on reducing carbon but that’s not enough…
…need to focus on adaptation
To be fair, the focus has been on reducing carbon and try to slow down climate change. Unfortunately, these actions have not been enough; temperatures are continuing to rise. The impacts are real, and we can already feel it; therefore, we need to focus on adaptation.
Recently these risks and the need for adaptation have started to get more attention:
- It’s harder to ignore – we can feel the impacts of climate change with more intense droughts, typhoons and floods;
- New research shows that time is running out – we only have 11 years to get things right;
- Mainstream investment bodies and regulators are taking action such as the Financial Stabilities Board (FSB), the International Association of Insurance Supervisors (IAIS), Britain’s Prudential Regulation Authority (PRA), and China’s State Council; and
- Government regulations are beginning to impact business operations.
Even traditional NGO are linking water risks & economic impacts…
…banks are not immune
Even traditional NGO’s, which would normally focus on access to clean water, are linking water risks and their economic impacts. This is encouraging, as it’s a reminder that banks are not immune; they have provided loans to organisations / projects that could be impacted by water but have not assessed these risks. More of these reports could help get the ball rolling.
However, a few key points are routinely missed but should be given more attention:
- Location, location, location; granular mapping is essential. As water and climate change risks are locational, the only way to recognise the hotspots is by mapping the assets. As a significant proportion of GDP is generated along river basins that are vulnerable to climate and water risks, banks should add river basin risks to their risk framework. This mapping can be done today without sophisticated models; for example, in 2016 we mapped the assets of 5 coal and 5 power companies, which highlighted the level of risk exposure of their balance sheets.
- Climate change and water are intrinsically linked because water is the primary medium through which we will feel the effects of climate change. In addition, water scarcity limits climate change solutions and climate change limits water scarcity solutions.
- All sectors will be affected; diversification by sector is not enough. Typically, the power, agricultural and mining sectors get the most attention as they are water intensive. However, the financial performance of a textile manufacturer, a hotel chain, or a semiconductor manufacturer would also be affected if their direct operations and/or supply chain is impacted by a surplus or scarcity of water.
- Fiduciary duties are being ignored. A prudent bank or investor should consider all material financial risks, unfortunately most are yet to fully incorporate water risks. Some have started to consider ESG data, but this is not enough as it is not a key area of the investment process and current corporate disclosure does not match the rising risks.
- Water related opportunities are not confined to the water sector. Since every sector is affected by water, there will be innovations and thus opportunities in each of them. Textiles that require less water to be manufactured and new types of food technology that need less water are just a few examples.
- China is taking the lead. In 2016, under its G20 Presidency, China established the Green Finance Study Group. China’s State Council ultimately wants to embed environmental risks into the credit lending policy thereby ensuring financial resilience. Therefore, in 2018 the central bank published the first ever 400+ page tome titled “Environmental Risk Analysis (ERA) by Financial Institutions”, which CWR co-authored. Currently, the report is only available in Chinese but watch this space!
To remedy this, they can start by mapping their assets…
In conclusion, water risks are financially material yet financial institutions are flying blind. To remedy this, they can start by mapping their assets, ensure the portfolio is resilient to these risks through tilts, divestments and engagements; and find new opportunities. Until this changes, our savings are at risk.
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