You can imagine the effects that could arise should Jobo have succeeded! As food for thought, who would have suffered most from Jobo? Any ideas of the Jobo-related losses that could have occurred from a banking sector outlook? Most literatures and studies have seemed to embark on the impact of climate change on the economy, and how countries and regions are impacted by related loss events, with a little focus on the impact of such events on banks.
Notwithstanding, and mostly in the current arena of heightened climate change, it is important for banks to incorporate climate related risks to their traditional financial risks. The available bank-related studies have sought to analyse how climate risk drivers give rise to financial risks, and this is what banks in Tanzania should aim at.
In that light, the Basel Committee on Banking Supervision, in April 2021, issued two analytical reports on climate related risk drivers and their transmission channels as well as climate related financial risks – measuring methodology.
The former report highlights the effects of climate-related financial risks and how they can translate into bank’s financial risks by expounding some key components. For starters, banks need to consider “climate risk drivers.” Climate risk drivers represent all sorts of climate-related changes that could give rise to financial risks i.e. the traditional market, credit, operational, reputational, liquidity and even currency risks.
Climate risk drivers could be physical risks arising from the changes in weather and climate that impact economies or they could be transition risks arising from transitioning an economy that is reliant on fossil fuels to a low-carbon economy. For the case of Tanzania, such physical risks could result into damage to properties, infrastructure and agriculture which could potentially generate financial losses to the banking sector.
From a credit risk perspective, much higher impairments would be expected for customer in specific geographical locations or sectors that may be directly impacted by such physical risks which may reduce the borrower’s ability to repay or hinder the bank to fully recover the asset in the event of a default. This remains an area of management judgment to ascertain and assess the magnitude and timing of the climate risk drivers on their business.
On top of that, “transmission channels” is also a key component to consider. As explained by the Basel Committee, transmission channels could either be micro or macro-economic transmissions. Microeconomic transmission channels could impact the bank’s credit risk through its counterparties; market risk could be heightened due to diminishing value of financial assets whereby calamities could trigger prices reduction and increase market volatility in traded asses.
At times, liquidity risk could increase as banks’ access to funding is reduced due to changes in market conditions. Climate risk drivers may also cause banks’ counterparties to draw down deposits and credit lines. There could also be an increase in reputational risk due to changing market or consumer sentiments resulting from climate risk. Generally, transition risk drivers are likely to affect the income of banks’ counterparties, which, in aggregate, could have massive macroeconomic effects.
Again, it is important for banks to understand that the impact of climate risk drivers can be affected by the geographical heterogeneity of their portfolios, amplifiers such as interactions and interdependencies between transmission channels as well as mitigants that reduce or offset impacts through both reactive and proactive actions.
Having navigated through the risks, banks are now called upon to establish and/or incorporate into their current structures, methodologies to adequately measure climate risk and properly account for it while also dealing with the related challenges such as data gaps and the uncertainties of predicting climate change. It’s time to gather pace!
Jennifer Kajuna is an Audit Manager at KPMG in Tanzania ([email protected]).The views and opinions expressed here are her own and do not necessarily represent those of KPMG.