The banking crisis could be fueled by climate change

Property damage from floods, wind, storms, hail or wildfires threatens a collective $2.4 billion at nearly 200 national banks, representing an average of 1.5 percent of those banks’ total portfolio value, according to First Street . Most of this risk is concentrated among small regional or community banks. In fact, nearly one in three regional banks face significant climate risks. But large institutions are not immune, one in four also face such risks, the report shows.

“Risk exposure varies, but regardless of the size of the institution, all banks have had some level of climate risk in their lending footprint,” said Jeremy Porter, First Street’s head of climate implications. wealth. “The most vulnerable were regional, small and community banks with highly concentrated portfolios in areas prone to floods, fires or hurricanes. However, even some of the larger banks faced significant enough risk to warrant further consideration.”

First Street conducted its analysis by looking at extreme weather risks at banks’ physical locations and using that as a proxy for the commercial and residential properties on which banks issued loans.

Nearly a third of the nation’s banks are exposed to climate-related risks that could reduce the value of their holdings by 1 percent, a threshold defined by the Securities and Exchange Commission as significant.

“If you have any line item, as a publicly traded company, with the potential to lose 1% of value … you have to report it,” First Street CEO Matthew Eby said. “On average, each of these small banks and community banks has so much risk that they all (should) report it.”

Why the banks don’t know

The SEC’s 1% rule is currently on hold while it faces legal challenges, but regardless, it and other financial reporting requirements exempt small banks. Experts say many of these institutions probably don’t know how risky their portfolios are. And the rising costs of weather-related disasters, which are expected to rise dramatically as climate change worsens, show why understanding such risks is critical. Since the 1980s, floods, wildfires, hurricanes, and other weather disasters have caused an increasing amount of financial damage, much of it in areas previously immune to weather disasters.

Hurricane Debby, which hit Florida and the Carolines last month before moving up the East Coast, caused an estimated $1.4 billion in property losses in the US and more than $2 billion in Canada, according to estimates. (It was the most expensive event in the history of Quebec, Reinsurance news But an analysis by First Street found that nearly 8 in 10 of the damage was outside FEMA’s historic flood zones, meaning affected properties are unlikely to have flood insurance and their homeowners less able to against a catastrophic financial loss.

Repeated across hundreds or thousands of properties, such financial losses could spell disaster for small banks that have bad loans concentrated in one area. A bank flagged as high risk by First Street has the most branches in coastal New England, a region that has seen back-to-back devastating floods in the past two years and where climate change is expected to exacerbate extreme weather.

“If you’ve lost, after insurance, 14 or 15 percent of your residential real estate portfolio or commercial real estate portfolio, there’s no way you’ve got the reserves to last, so you’re talking about potentially bankrupting a bank,” Eby said.

He added, “financial institutions are really the big concern, because if they fail in financial crises, that affects everyone else, as opposed to a company failing on its own.”

Unknown unknowns

While climate risk is a growing concern for banks of all sizes, the smallest institutions are the least able to determine and price that risk, said Clifford Rossi, a former Citigroup chief risk officer who he now directs the Smith Enterprise Risk Consortium at the University of Maryland.

“So many other things are affecting the small banks — they’re dealing with competitive pressure from the big guys affecting economies of scale, they’re fixated on how they manage their assets, interest rates are going down … those things are at the top . lie,” he said.

Rossi questioned First Street’s methodology and cautioned against putting numerical estimates of bank losses based on branch locations, saying they could give wildly varying figures.

“There is certainly a degree of risk in these portfolios, but we don’t know how much,” he said.

Each bank should do a loan-level analysis of their portfolio, putting address, longitude, latitude and commercial real estate data into a climate model to assess physical risk, he added.

When it comes to estimates, he cautioned, “We have to be careful about saying the sky is falling when we don’t yet have the best analysis in town.”

But this kind of analysis takes time and is difficult, even for the largest institutions. The Federal Reserve this spring released the results of a test to determine how aware America’s six largest banks — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo — were about their climate risks.

The answer: Not really.

According to the banks, they did not have reliable information about the types of buildings they owned, their insurance coverage, weather exposure or climate modeling data.

The new analysis “highlights the need for all banks, financial institutions and asset owners to proactively incorporate climate risk into their broader risk management frameworks,” First Street’s Porter said.

“Climate risk is present in these portfolios – and it is measurable. The Federal Reserve, the SEC and other regulators already recognize this risk through stress testing, and it is only a matter of time before mandatory reporting becomes standard practice.”