Banks plan to cut their investments in industries and regions at risk from climate change

Australia's largest banks predicted that they would adjust their risk appetites and lending practises in response to rising climate-related losses, with potential actions including cutting back on high loan-to-valuation mortgage lending and reducing exposure to sectors such as mining, manufacturing, and transportation, according to a new study released today by the Australian Prudential Regulation Authority, a financial services regulator (APRA).

ARPA conducted its first Climate Vulnerability Assessment (CVA) with the country's five largest banks: ANZ, Commonwealth Bank, Macquarie Bank, National Australia Bank, and Westpac. The assessment modelled the estimated future financial impact of climate change on their businesses, as well as their potential responses to physical and transition climate risks.

The participating banks based their analyses on two Network for Greening the Financial System (NGFS) scenarios that reflect a variety of possible future climate policies, physical risks, such as heat, drought, and floods, and short- and long-term risks stemming from the transition to a greener economy, such as rising carbon prices. The scenarios included a Delayed Transition Scenario in which policy action on climate change is delayed, followed by a rapid reduction in global emissions after 2030, and a Current Policies Scenario indicating a future in which global emissions continue to rise beyond 2050.

The analysis indicated that while climate risks under the investigated scenarios were unlikely to have a significant impact on the banking sector, banks could incur increased portfolio losses from physical and transition risks in the medium to long term.

Helen Rowell, deputy chair of the APRA, said:

"The results show that banks' lending portfolio losses could increase over the medium to long term as climate change and the global reaction to it develop. Climate change could make the banking sector more vulnerable to future economic downturns, despite the fact that these impacts are not likely to pose a significant threat to the financial system."

Both scenarios were found to result in a significant increase in losses resulting from transition risks within business lending, with losses being bigger under the Delayed Transition Scenario. Per 2050, mortgage lending outcomes varied significantly by the bank, ranging from no climate-related losses to lending loss rates about three times greater than historical norms.

It was discovered that climate-related risks are concentrated in particular regions or industries, including significantly higher mortgage losses in areas, such as parts of Northern Australia, more exposed to severe and prolonged physical risk, and some sectors more exposed to transition risks, including mining, manufacturing, and transportation. The banks suggested in response that they would modify their risk appetites in these sectors.

Director of Policy at the Investor Group on Climate Change (IGCC), Erwin Jackson, stated, in response to the assessment's findings:

"The analyses indicate that banks are altering their lending procedures, which entails withdrawing from weak businesses and regions. In response to climate hazards, investors have also adopted similar strategies."

The study also highlighted a need for improvements in data quality and accessibility, with significant variation in the results of the banks due in part to the use of diverse modelling methodologies and data granularity.

Jackson added:

"APRA makes a strong case that the results are highly variable since the models are new and the data is incomplete.

"Therefore, the government must expand financing for the underlying climate science, and financial institutions must greatly enhance their analysis that translates the science into comprehensive climate risk models."