Major Aussie banks like CBA and Macquarie could be hit hard by climate change, warns APRA

Climate change is bad for business, not just the planet. Australia’s leading oversight authority warned the nation’s top five banks this week that unless they take action, their finances could take a loss in the coming years – leaving them vulnerable to future economic shocks. 

Let’s unpack what these findings could mean for the future of banking and sustainable finance.

Over the last two years, Commonwealth Bank, NAB, NAZ, Westpac, and Macquarie Bank participated in a study with the Australian Prudential Regulation Authority (APRA) looking into how well their businesses can absorb the impacts of climate change. 

APRA released the results this week as the first Climate Vulnerability Assessment (CVA), exploring how various climate scenarios expose weak points in the banking system.

Chief among the risks faced by the big banks are:

• Physical risk, such as damage to assets and properties. This leads to supply-chain disruptions (driving inflation), mortgage defaults, and an increase in catastrophe insurance claims.
  
• Transition risk, which highlights the banks’ inability to cope with societal changes. As the economy adjusts to a low-emissions mindset, the banks must adapt to new policies, technologies, and social expectations. 
  
• Liability risk. Finance laws and regulations will need to keep pace with climate change, which could leave banks vulnerable to non-compliance and corporate liability costs. Litigation may disrupt business operations, while penalties could impact their bottom line. 
  

For example, the banks assessed how nearly $1.7 trillion in home loans could be affected by the physical impacts of severe weather events. Repeated catastrophes would drive up insurance premiums and potentially put people behind on their repayments. Nothing worries banks quite like a potential cascade of mortgage defaults.  

It’s important to note that not every bank would face the same challenges or effects of climate change. Regional banks will struggle differently than international banks, and so forth, because of various business and environmental factors. 

Additionally, many impacts are highly dependent on the state of affairs. If the economy completely deteriorates because of unchecked global emissions, then this worsens matters for the banks (and everyone else) much more than an optimistic, sustainable outlook.

However, APRA conceded that none of the potential impacts shown by the study were ‘severe’, even in some of the worst-case scenarios. The big banks could simply absorb the costs as they’ve done with disruptions caused by COVID-19.

But this doesn’t mean climate change remains ideal or acceptable. On the contrary, APRA warns that climate stress weakens the banks’ overall standing. When the next recession inevitably strikes, it’ll hit their margins all the harder.

Besides, the study only evaluated the financial risks posed to banks, not the dire ones facing the globe. Banks play a significant role in funding industries that worsen climate change, like fossil fuels. To properly green the future, banks must be part of the solution.

Institutions worldwide have been assessing themselves for climate-related risks for a few years now, but this task is made difficult by a lack of consistent, universal regulatory standards. 

In essence: there is no clear-cut way of determining which banks are sustainable and which aren’t.

“Despite the high profile of climate change, climate risk management and modelling remain emerging areas of expertise, in part due to uncertainty about how the risks will play out decades into the future, and how these risks are incorporated into financial models,” said APRA deputy chair, Helen Rowell.

So if nothing else, the CVA reminded the big banks that it’s vital to change with the times and that climate risk is a new area requiring exploration and development.

All banks in the study predicted they would have to adapt their lending practices to manage future climate risks, such as tightening loan-to-value ratio limits and avoiding high-risk industries and regions like Northern Australia. 

These changes may also restrict who can access loans in the first place – low-income home buyers may have reduced borrowing power, which could lock them out of certain property markets. Meanwhile, demand for green banking products like ESG funds will skyrocket, fundamentally changing the economic landscape. 

APRA reckons the survey findings could also apply to other Australian financial bodies, such as insurance providers and Super funds.

“We urge all APRA-regulated entities to examine the CVA findings to see how they can leverage the insights to enhance their own climate risk analysis and management,” says Rowell.

Many banks have also greened their businesses in hopes of halting climate change, not just protecting their profits. For more information, check out our guide to ethical banking.