Rest a Little Easier Tonight: Climate Change Has Minimal Effect on Your Bank's Operational Risk

Regulatory bodies, standard-setting organizations, NGOs, policymakers and banks themselves have increasingly focused their attention on how banks should disclose their climate change risks. Implicit in this interest is an assumption that climate change risks are potentially significant enough to pose safety and soundness issues for banks or stability issues for the financial system. For example, a recent BCBS consultative document on climate risk disclosure asserts that climate risks “…result in financial risks to banks … potentially affecting the safety and soundness of banks and the stability of the broader banking system.”[1] That said, research on the magnitude of climate change risk for banks has so far not identified significant effects. Recognizing the lack of empirical evidence, the BCBS proposed a climate risk research program in 2021,[2] noting that most research to date has been on credit risk with little analysis or attention devoted to market, liquidity and operational risks.

Advertisement

A recent study by Berger et al.[3] adds to the climate change evidence by quantifying the effects of extreme storms on large U.S. banks’ operational risk losses. The study finds that a doubling of its proposed deposit-weighted measure of large banks’ exposure to storm damage would result in an increase in operational risk losses of $22 million on average.

Berger et al. conclude their analysis by suggesting that the effects of climate change on op risks should be included in regulatory frameworks. However, in absolute terms, $22 million is a very small increase in operational risk losses that would not affect the capital adequacy of a bank or impose systemic risks on the banking system. Furthermore, even the immaterial $22 million estimate is significantly overstated. This overstatement arises because approximately 80 percent of these operational risk losses result from “Clients, Products and Business Practices,” the majority of which originate from agreements with the Department of Justice and other organizations to settle allegations that banks misled residential mortgage-backed securities investors in the years before the financial crisis. Thus, the largest operational risk losses composing the $22 million estimate were unrelated to climate events. Leaving aside the RMBS issue, the $22 million estimate overstates the effect on most banks. Extreme hurricanes are geographically concentrated in Florida, Louisiana and Texas. (And presumably banks in those states are more experienced in and focused on managing that risk.) Similarly, flood risk and other physical risks, such as wildfire risk, are confined to specific geographic locations and do not affect all banks equally (or at all), and thus do not pose systemic risk.

Advertisement

[Well…WHEW! And there goes yet another climate cult argument. ~ Beege]

Join the conversation as a VIP Member

Trending on HotAir Videos

Advertisement
Advertisement
Advertisement