Climate change, the FDIC and a Brexit bluff

The week on Risk.net, August 25-31, 2018

7 days montage 310818

Stress tests expose climate risks in loan books

Efforts to quantify risk of global warming are changing the way banks manage credit portfolios

To be resolved: the FDIC and the future of bank failure

Will Jelena McWilliams finally nail down the FDIC’s role as a resolution authority?

UK Treasury never analysed impact of risk weights for EU debt

Risk weight move seen as political threat to EU sovereign issuance to force Brexit equivalence deal

 

COMMENTARY: The uncertain worst

The problem’s not so much that it’s going to be bad. It’s that we really don’t know quite how bad, or in which specific ways bad.

This is actually about climate change, not Brexit, or any of the other large downside risks now slouching their way out of the tail of the distribution towards us. Earlier this year, we looked at the ways in which major banks were starting to incorporate climate risk into their stress tests – including impacts as diverse as tighter emission regulation and drought-caused harvest failures. This week we revisit the story and look at the first results of the tests.

They make interesting reading – many banks are only now discovering the full complexity of climate risk stress testing, an order of magnitude beyond the kind of market or credit risk tests that have been routine for years. It’s also put the spotlight on what will be required if (as many regulators and lobbying groups want) disclosure of climate risk exposures becomes routine. It requires far more detailed and granular loan-level information, on areas from height above water level (flood risk) to annual emissions, even to exposure to the risks of likely transition routes to a post-climate-change world, and extending out over a much longer planning horizon.

Ethical and reputational concerns are also pushing banks away from high-carbon and other polluting businesses, but at least one banker we spoke to points out that the new climate awareness could mean opening new businesses as well as restricting existing ones. “If a business can derive revenue from these issues, it will attract a lot more capital,” says Matthew Arnold, global head of sustainable finance at JP Morgan Chase. “For a lot of banks, it’s what you say ‘no’ to. We’ve been trying to flip that around to what you say ‘yes’ to.” Driving new investment to clean energy or areas of lower climate risk exposure more broadly could represent a valuable new market, his counterparts at other banks argue.

Thrown in on top of all this, of course, is uncertainty around policy – at its greatest in the US at present, and in Europe thanks to the Brexit negotiations, but set to make significant differences to emissions trading, coal production and the power storage sector. Bank risk managers will need to stay on the ball.

 

STAT OF THE WEEK

European Union banks have dramatically cut their default risk estimates for corporate borrowers globally over the last three years. The average weighted probability of default (PD) for corporate exposures across 39 countries was 2.61% in the first quarter of 2018, down from 3.81% in the first quarter of 2015 and a peak of 4% in the second quarter of 2015

 

QUOTE OF THE WEEK

“Ideally, the equivalence regime will recognise trading venues established in the UK as meeting the same level of regulatory oversight, thereby allowing us a much smoother transition. Currently, however, the uncertainty is creating an environment in which we must prepare for every eventuality” – Michelle Zak, Kyte Broking

 

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