A new report from George Gallagher, ESG, Climate Risk, Natural Hazard and Spatial Solutions from CoreLogic, and Kent David, Senior Leader, Analytics Consulting from CoreLogic, titled “The Five Biggest Challenges for Banks When it Comes to Climate Risk” analyzes current climate risks and the Federal Reserve Board review of supervised institutions such as banks that are “appropriately managing all material risks, including financial risks related to climate change.”
The report notes that while some areas of the U.S. are safer for property, locating those areas and understanding how the evolving climate will affect physical risk is a tall order for banks and institutions tasked with forecasting future risks associated with a real property investment.
The report notes that the Federal Reserve Board is conducting a Climate Analysis Exercise due July 31, 2023, to learn about climate risk management practices in large banking organizations.
On January 17, 2023, the Federal Reserve launched its pilot Climate Scenario Analysis exercise (CSA) by publishing instructions for the six US banking organizations that will participate. As part of the CSA, participants will submit data and documentation on climate risk management practices that banks should consider reviewing to better understand the Federal Reserve’s expectations.
Five major points that the author notes related to climate risk management are as follows:
- Calculating physical risks in non-credit terms: Banks have not often been asked to examine climate-related physical risks, so it’s rare that they have a strong methodology prepared to do so.
- Lack of common terminology: With terminology differing among experts, the establishment of a common language is a step in the right direction for the industry.
- Financially quantifying physical risk: In determining physical risk, one must determine how much collateral is worth, and exactly what parameters are required to adjust that worth.
- Understanding the probability of default: With physical risk and transition risk being factored into the equation, most banks may have to rework their definition of exactly what default is.
- Complex climate risk variables are very different from credit risk variables: Considering the many variables involved in climate risk, the geographic distribution and time horizons associated with those risks are important when quantifying these climate-related events. While modeling future scenarios that include evolving climate risks in varying severity scenarios can make calculations more complex, solving them is not impossible.
Click here for more information on CoreLogic’s “The Five Biggest Challenges for Banks When it Comes to Climate Risk” report.