Global warming to trigger higher bank loan losses, particularly in Queensland and Northern Territory

Australia’s top banks will endure higher loan losses and more vulnerability to economic downturns due to climate change.

Australia’s top banks will endure higher loan losses and more vulnerability to economic downturns due to climate change. Picture: AFP

The nation’s biggest banks will endure higher loan losses and more vulnerability to economic downturns due to climate change, even though they are unlikely to confront “severe stress” from global warming.

Those are among the findings by the Australian Prudential Regulation Authority, which aggregated Climate Vulnerability Assessments conducted across 2021-22 by the banks on their businesses. The assessments were conducted by ANZ, the Commonwealth Bank, National Australia Bank, Westpac and Macquarie Bank.

The APRA report comes as the federal government prepares to release a consultation paper next month on the implementation of a climate disclosure framework for large businesses and financial institutions.

APRA’s report noted varied results across different banks, regions and sectors, noting that across home loan books the climate assessment results ranged from no lending losses being directly attributable to the climate scenarios, to loss rates swelling to about three times higher than historic averages by 2050.

“In the absence of a severe deterioration in macroeconomic conditions, these losses are unlikely to rise to a level that would result in severe stress for the banks,” APRA said. “The results provided by the banks for the counterparty assessments suggest that counterparty credit ratings would be negatively impacted under each of the climate scenarios, with the scale of impact likely to differ across different industry sectors.

“The potential for higher losses arising from climate change could lead to the banking sector being more vulnerable to future economic downturns.”

The report – which had the five banks assess potential outcomes from two distinct scenarios — saw losses in some regions increase markedly, with a number experiencing a “substantial increase” in climate risk.

APRA highlighted that Queensland and the Northern Territory showed the “most meaningful increases” in loan loss rates from 2030 to 2050. Under one scenario, weighted-average loan loss rates in Queensland are expected soar by more than 30 per cent by 2050.

“Mortgage exposures in 80 per cent of postcodes incur around 25 per cent of total losses – with virtually no losses in the lowest 40 per cent of postcodes by climate risk – while the most impacted 20 per cent of postcodes accounts for around 75 per cent of total losses,” the report said.

It assessed the impact of extreme weather events such as flooding or heatwaves and risks associated with gradual shifts in the climate. The first scenario explored delayed policy action on climate change, followed by a rapid reduction in global emissions after 2030, while the second scenario assessed a continued increase in global emissions beyond 2050.

Australia’s top banks will endure higher loan losses and more vulnerability to economic downturns due to climate change. Picture: AFP

APRA deputy chair Helen Rowell said the results of the assessments showed climate change would throw up some future financial challenges for both banks and borrowers.

“The results suggest that banks’ losses from their lending portfolios could rise in the medium- to-long-term as climate change and the global response to it unfolds. Although those impacts are not expected to cause severe stress to the banking system,” she added.

Treasurer Jim Chalmers noted the assessments made a “really significant contribution” to understanding the risks of climate change in the banking system.

“This process helps ensure decision-making is more fully informed – that’s critical for customers, businesses, investors and the overall stability of our financial system,” he said.

“Our government is not wasting a day in responding to the challenge of climate change and grasping the economic opportunities presented by cleaner, cheaper and more reliable energy.

“That’s why we are working to develop a framework for climate disclosure.”

Treasurer Jim Chalmers said the climate assessment made a ‘significant contribution’ to understanding the risks to the banking system. Picture: Nikki Short

APRA’s climate vulnerability assessment requirement for the banks has similarities to initiatives rolled out in other markets, including by the Bank of England and European Central Bank.

But the APRA-led assessments drew some criticism on Wednesday.

The Investor Group on Climate Change’s policy director Erwin Jackson said loan losses were being underestimated by Australian banks because they were not factoring in limitations around the adaptation of infrastructure, compounding extreme weather events or large economic shocks.

“One of the things that has been pointed out quite strongly by the central banks globally is … these assessments are underestimating the risk,” he added.

The Australian Conservation Foundation’s corporate campaigner Jonathan Moylan said the nation’s banks had “a long way to go” to more accurately determine the impacts of climate change on their loan portfolios.

“It’s clear that increasing droughts, floods and extreme heat will cause substantial losses to agriculture and residential mortgages,” he added.

“The assessment shows 6 per cent of bank counterparties would be in default by 2050 under a delayed transition scenario.”

As part of the exercise the participating banks also conducted an evaluation of climate risk and credit quality on 25 of their largest non-financial counterparties.

APRA’s report identified sectors, including mining, manufacturing, transport, and wholesale trade, as showing higher business lending losses in the transition towards a lower emission economy. In agriculture, the report found the grain and beef sectors were most impacted under one of the scenarios.

“The impacted regions and sectors represent a small proportion of participating banks’ overall lending exposures and are therefore unlikely to lead to significant increases in lending losses in aggregate,” it said. “However, these conditions could present a risk to less diversified banks.”

The report also suggested while the banks would continue to lend in the overwhelming majority of cases, some flagged they could change their lending criteria and pull back in some riskier areas.

“The banks indicated that this stance was partly contingent on additional policy support for more at-risk regions,” it said.

The report also raised significant issues around climate-related data quality as banks assess the emissions and risk profile of their customers.

But APRA said while data issues were real, it shouldn’t deter banks from pushing ahead with climate risk initiatives.

The regulator’s report aligns with a paper released last week by McKinsey & Company.

It highlighted the challenge for banks around sourcing reliable data on customers’ emissions.

APRA said: “Although future improvements in data availability and quality are expected, data limitations do not provide a justification for delaying initiatives to better understand climate risk.

“Notwithstanding the differences in the banks’ current climate risk approaches, the CVA has stimulated further development of their overall climate risk assessment capabilities, as well as identifying areas for improvement.”

The McKinsey Global Institute estimates the shift to net-zero will require about $US9 trillion per year in capital expenditure until 2050, spanning areas such as transport, buildings, infrastructure, power and agriculture.

APRA published the aggregated results of the climate vulnerability assessments, but not individual bank results.