Climate hit to bank profitability could exceed 15pc: investors

Australia’s emissions-intensive economy means the climate hit to bank profitability may exceed the 10-15 per cent range in a stress test by a UK regulator.

Australia’s emissions-intensive economy means the climate hit to bank profitability may surpass the 10-15 per cent range in a stress test by UK’s Prudential Regulation Authority. Picture: Jason Edwards

A landmark stress-test by the UK prudential regulator projecting that climate risks will be a persistent, 10-15 per cent drag on the profitability of the country’s banks and insurers could understate the impact in Australia, warns an influential investor group.

The Investor Group on Climate Change, representing Australian and New Zealand investors with $3.6 trillion in funds under management, said the economic and financial costs of climate change were likely to be larger in Australia than the UK, all else being equal.

“Australia’s economy is more exposed to climate risk than any other advanced economy – our economy is very emissions-intensive and that has a flowthrough to financial institutions,” IGCC chief executive Rebecca Mikula-Wright said.

“For example, every dollar invested in the overall ASX200 exposes investors to twice the carbon risks compared to other major markets.

“It is positive that our local regulators have started to do the necessary stress tests.”

The Prudential Regulation Authority – the UK equivalent of APRA in Australia – announced the results of its stress-test overnight on Tuesday, saying the cost of transitioning to net zero emissions by 2050 looked “absorbable” for banks and insurers, with no direct impact on their solvency.

However, PRA chief executive Sam Woods said that the forecast drag on average annual profitability was a big number, and could be even larger due to some significant exclusions.

“By themselves, these are not the kinds of losses that would make me question the stability of the system, and they suggest that the financial sector has the capacity to support the economy through the transition,” Mr Woods said.

“But any positive message needs to be taken with a major pinch of salt: both because there is a lot of uncertainty in these projections and because this drag on profitability will leave the sector more vulnerable to other, future shocks.

“A world with climate change is a riskier one for the financial system to navigate.”

The Bank of England, incorporating the PRA, is widely thought to be ahead of the game in climate-change policy formulation and research after Mark Carney’s period as governor from 2013 to 2020.

Mr Carney is now the UN special envoy for climate action and finance, and was finance adviser to Boris Johnson for the COP26 climate conference in Glasgow.

Locally, the Australian Prudential Regulation Authority is conducting climate vulnerability assessments to examine the financial impact of climate change, among other things.

At this stage, the CVAs are limited to the nation’s five biggest banks.

An interim report is due by September, and an information paper on the aggregate findings will be released before the end of the year.

APRA, chaired by Wayne Byres, has also kicked off a climate-risk survey of medium-to-large regulated entities, asking them to self-assess how their current practices stack up against the regulator’s guidance on managing the financial risks of climate change.

An overview of the findings will be published in the next two months.

Mr Woods said the second big lesson from the PRA exercise was that costs to the financial sector would be significantly lower if the transition was both early and orderly.

A late and abrupt transition would trigger a “messy” recession, with rising unemployment as the corporate sector adjusted.