Climate change is a grave global issue that impacts us all. For too long, policymakers, businesses, and consumers have turned a blind eye to the impact this is having on our world, and we are now at a critical juncture where it can no longer be ignored. The National Oceanic and Atmospheric Administration (NOAA) released its annual research on climate events earlier this year, reporting that there were 20 weather and climate disasters in the US in 2021 that caused $1B or more in damage. Collectively, these events caused over $145B in damage – an astounding figure. NOAA’s research also shows that the average number of annual billion-dollar events continues to increase – with an average of 17.2 over the past five years, compared to 5.3 during the 1990s.
Given this, it’s perhaps unsurprising that businesses across the world are assessing how to reduce their carbon footprint – homebuilders are having to consider the sustainability of the materials they use or risk seeing planning applications rejected; restaurants are updating menus to cater to vegan, vegetarian and flexitarian diets; retailers are looking into replacing the type of packaging they use with recyclable alternatives; farmers are examining how to reduce their use of fertilizers and pesticides. The list goes on.
Consequently, these changes are impacting the profitability and long-term sustainability of some of the most resilient businesses across the globe, posing both challenges and opportunities for lenders as they look to fundamentally re-evaluate how balance sheets, income statements, and operating models are accessed. Traditional methods of assessing borrowers based on ESG disclosures and CSR initiatives alone are no longer sufficient, as these do not measure companies based on climate-related challenges. As a result, stakeholders - from governments, central banks, business owners, investors, and boards - are increasingly focused on the implications of climate change as a key risk to the stability of banks.
As the demand for sustainable solutions increases, this highlights the unique role of the banking industry in supporting the transition to a more sustainable future. Banks will play a vital role in the provision of capital to finance the investment in renewables, climate adaptation technologies, as well as finance the growth in more sustainable ways of living e.g. vegan restaurants, electric cars, EV pumps, and sustainable homes, to name a few. Examples of this can be seen via OakNorth Bank’s recent transactions with Verto and GR33N Homes, where we’ve supported the development of a significant number of sustainable homes, as well as our £20M deal with Mumbles Group, that saw us fund the development of more than 20 forecourts across the UK with EV pumps.
Turning to the US again, with current technology, the cost of full decarbonization of the country’s power grid is more than $4.5T. But rather than a cost, at OakNorth, we see it as a $4.5T opportunity, for banks to help their commercial customers transition to the green economy, largely driven by consumer demand.
In addition to our lending operations in the UK, we’re also supporting US banks with their green ambitions, through the OakNorth Climate Impact Framework. The Framework provides powerful insights that enable banks and financial institutions to get ahead of climate-related risks and opportunities in a data-driven manner, enabling smarter, faster, and more proactive decisions across the credit life-cycle.
The Framework covers two distinct categories of climate risk – Transition Risk and Physical Risk. Transition Risk identifies how low-carbon policies, investment in clean / remediating technology, changes in price elasticity, and evolving consumer sentiment impact specific sub-sectors and the resulting credit risk within a bank’s loan portfolio. Physical Risk evaluates how extreme weather events such as: floods, drought, hurricanes, etc. can lead to business disruption and damage to property. It also addresses how long-term changes in climatic patterns, such as rising temperatures, change in precipitation, increasing sea levels, desertification, etc. can affect labour, capital, and agricultural productivity.
We apply these scenarios across our repository of 273 sub-sectors to assess and classify each sub-sector at a granular level, based on carbon emission impact, as direct impact, indirect impact, or residual impact. These scenarios are overlaid on 14 borrower data points (which can be readily extracted from spreading and core banking systems), allowing lenders to holistically understand the impact across policy-driven and supply-chain driven operating costs, capital expenditure for clean or remediating technology, and revenue changes driven by shifts in demand or disrupted operations.
This provides a forward-looking climate risk score from low priority (least vulnerable) to high (most vulnerable), empowering relationship managers, credit officers, and risk managers to make better, more informed decisions on which borrowers or sub-sectors in their portfolio are most likely to suffer or benefit from climate changes. These insights can be applied across the full credit lifecycle, from origination and ongoing monitoring, to conducting portfolio level scenario analysis, responding to investor, board, regulatory requests, and setting credit strategy.
Looking ahead, climate change is an area where executive management and the board of directors at banks need to take a very active role in setting the direction of travel. Institutions are going to differ in terms of their strategy, client selection, and risk appetite, and there are significant challenges that need to be addressed. However, for banks that are willing to be proactive, climate change presents a huge opportunity to support customers through the transition to greener operations. This, in turn, will create positive ripple effects across its stakeholders – from investors to employees, customers to regulators.
 Green Tech Media - The Price of a Fully Renewable US Grid: $4.5 Trillion