Climate change is recognised by many as one of world's biggest threats. In an attempt to halt the damage, Governments around the world have set ambitious emissions targets, with the United Kingdom, Japan and the Republic of Korea, together with more than 110 other countries, pledging to be carbon neutral by 2050.
To meet these ambitious targets – and secure a stable and sustainable future - we all have a responsibility to act. This responsibility is far reaching, from ethical consumerism and household recycling through to the strategic decisions of large corporations.
The effects of climate change extend far beyond the environment, having an impact on everything from international security to healthcare and the economy. As a result, many industries, including banking and finance, are changing the way they operate and are preparing for a more environmentally sustainable future.
The economy and the environment
The economy and the environment are closely linked.
Many economic activities, such as mining for oil and burning fossil fuels, contribute to climate change and pollution.
Changes in the environment can also impact the global economy. The catastrophic wildfires in Australia over the past two years are estimated to have cost nearly $100 billion.
“Climate change constitutes a major challenge, causing both threats and opportunities that will significantly affect the economy and the financial sector, depending on which carbon emission scenario eventually unfolds” says Christine Lagarde, President of the European Central Bank.
As climate change impacts biodiversity and increases the prevalence of natural disasters, this link means that the economy risks being destabilised by the progress of climate change.
A new set of risks
For the financial sector, climate change represents challenges – but also opportunities.
Climate risks to the economy can be divided into two categories; physical risks and transition risks. Physical risks are environmental events like floods or storms, whereas transition risks arise from changes in policy and new technologies, such as the growth of renewable energy.
A rise in natural disasters can have a significant impact on insurance and losses as well as the potential to affect the wider economy, for example if severe weather damage leads to a reduction in house prices, there could be a knock-on effect on overall spending.
One US trading regulator has claimed that the potential damage from climate change could be as severe as the fallout from the 2008 financial crisis.
According to the Bank of England, transition to a greener economy could lead to shifts in asset values or higher costs. For example, if policies change and fossil fuels can no longer be burned, the value of investments that banks and insurance companies have made in coal, oil and gas could be affected. As a result, some firms are already choosing to reduce investments into sectors like coal to help manage these risks.
Schemes like the COP26 Private Finance Agenda – an initiative that helps private finance support the global economy transition to net zero – are helping organisations to better understand the link between the environment and the economy and consider climate change in their strategic plans.
“The objective [of COP26] is that every professional financial decision will need to take climate change into account” reports the United Nations. “The right framework for reporting, risk management and returns will embed these considerations and help finance a whole economy transition. To achieve net zero, every company, bank, insurer and investor will need to adjust their business models for a low carbon world.”
As companies disclose more information relating to climate change, financial firms will also be able to make more informed decisions regarding climate risk. This is supported by legislation, such as the non-financial reporting directive (NFRD), which requires large EU companies to publish regular reports on the social and environmental impacts of their activities.
Invest in green innovation
Investment in green alternatives presents a huge opportunity for financial services. As we move closer to emissions target deadlines the demand for new, environmentally friendly technology, processes and services will increase.
“If climate change is an existential risk, which it is, and you are part of the solution, you are creating a tremendous amount of value” says Mark Carney, Former Governor of the Bank of England and Special Envoy for Climate Action and Finance.
As well as responding to regulatory pressure, experts believe that it is a commercial imperative for the financial sector to invest in the green agenda and help to fund the green innovations of the future.
According to Dr Steve Cohen, Director of the MSc Sustainability Management at Columbia University, environmental protection itself contributes to economic growth through the creation of new industries, products and jobs.
“Clean air and water, healthy food and preserved nature all benefit human health and result in far more economic benefit than economic cost” says Dr Cohen.
Building an environmentally sustainable economy
Banks and financial institutions are already responding to the risks and opportunities posed by climate change.
One bank that is committed to putting climate change at the centre of its policy making is Citi.
“As a global bank we responsibly provide financial services that enable growth and economic progress for the clients and communities that we serve” says James Bardrick, Citi Country Officer, UK. “Citi has been incorporating environmental, social and climate change into our financing for more than 20 years.”
In 2020, Citi released its 2025 Sustainable Progress Strategy which includes a commitment to increase their financing of environmental and climate solutions, including a new £250 billion environmental finance goal.
Although regulation increasingly requires banks to manage climate risk, many financial services still have a long way to go before they have fully incorporated climate change into their growth strategy.
“Some have made a start, but many must still formulate strategies, build their capabilities, and create risk-management frameworks” reports management consultants, McKinsey. “The imperative now is to act decisively and with conviction, so effective climate-risk management will be an essential skill set in the years ahead.”
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