The Topic That’s Missing From Strategic Discussions

As of Oct. 8, 2021, the U.S. experienced 18 weather-related disasters with damages exceeding the $1 billion mark, according to the National Oceanic and Atmospheric Administration (NOAA). These included four hurricanes and tropical storms on the Gulf Coast — the costliest disaster, Hurricane Ida, totaled $64.5 billion, destroying homes and knocking out power in Louisiana before traveling north to cause further damage via flash flooding in New Jersey and New York. Out West, the financial damage caused by wildfires, heat waves and droughts has yet to be tallied but promises to be significant. More than 6.4 million acres burned, homes, vegetation and lives were destroyed, and a hydroelectric power plant outside Sacramento even shut down due to low water levels.

These incidents weren’t unique to 2021. In fact, the frequency of costly natural disasters — exceeding $1 billion, adjusted for inflation — have been ticking up since at least the 1980s.

 

Scientists at the NOAA and elsewhere point to climate change and increased development in vulnerable areas such as coastlines as the cause of these more frequent, costlier disasters, but bank boards aren’t talking about the true risks they pose to their institutions. Bank Director’s 2021 Risk Survey, conducted in January, found just 14% of directors and senior executives reporting that their board discusses the risks associated with climate change at least annually. An informal audience poll at Bank Director’s Bank Audit & Risk Committees Conference in late October confirmed little movement on these discussions, despite attention from industry stakeholders, including regulators and investors that recognize the risks and opportunities presented by climate change.

These include acting Comptroller of the Currency Michael Hsu, who on Nov. 3 announced his agency’s intent to “develop high-level climate risk management supervisory expectations for large banks” above $50 billion in assets along with guidance by the end of the year. He followed that announcement with a speech a few days later that detailed five questions every bank board should ask about climate change. While his comments — and the upcoming guidance — focus on larger institutions, smaller bank boards would benefit from these discussions.

Hsu’s first two questions for boards center on the bank’s loan portfolio: “What is our overall exposure to climate change?” and “Which counterparties, sectors or locales warrant our heightened attention and focus?” Hsu prompts banks to dig into physical risks: the impacts of more frequent severe weather events on the bank’s markets and, by extension, the institution itself. He also asks banks to look at transition risks: reduced demand and changing preferences for products and services in response to climate change. For example, auto manufacturers including General Motors Co. and Ford Motor Co. announced in November that they plan to achieve zero emissions by 2040; those shifts promise broad impacts to the supply chain as well as gas stations across the country due to reduced demand for fuel.

Consider your bank’s geographic footprint and client base: What areas are more susceptible to frequent extreme weather events, including hurricanes, floods, wildfires and droughts? How many of your customers depend on carbon intensive industries, and will their business models be harmed with the shift to clean energy? These are the broad strategic areas where Hsu hopes boards focus their attention.

But the changes required in transitioning to a clean economy will also result in new business models, new products and services, and the founding and growth of companies across the country. It’s the other side to the climate change coin that prompts another question from Hsu: “What can we do to position ourselves to seize opportunities from climate change?

Some large investors agree. In Larry Fink’s 2021 letter to CEOs, the head of BlackRock reaffirmed the value the investment firm places on climate change, noting the opportunities along with the risks. “[W]e believe the climate transition presents a historic investment opportunity,” he wrote in January. “There is no company whose business model won’t be profoundly affected by the transition to a net zero economy – one that emits no more carbon dioxide than it removes from the atmosphere by 2050. … As the transition accelerates, companies with a well-articulated long-term strategy, and a clear plan to address the transition to net zero, will distinguish themselves with their stakeholders.”

Some banks are positioning themselves to be early movers in this space. These include $187 billion Citizens Financial Group, which launched a pilot green deposit program in July 2021 that ties interest-bearing commercial deposits to a sustainable-focused lending portfolio. The challenger bank Aspiration launched a credit card in November that plants two trees with every purchase. And $87 million Climate First Bank opened its doors over the summer, offering residential and commercial solar loans, and financing environmentally-friendly condo upgrades. Climate First is founder and CEO Kenneth LaRoe’s second bank focused on the environment, and he sees a wide range of opportunities. “I call myself a rabid environmentalist — but I’m a rabid capitalist, too,” he told Bank Director magazine earlier this year.

 

Select Green Initiatives Announced in 2021

Source: Bank press releases and other public information

Climate First Bank (St. Petersburg, Florida)
Specialized lending to finance sustainable condo retrofits and residential/commercial solar loans; contributes 1% of revenues to environmental causes.

Citizens Financial Group (Providence, Rhode Island)
Launched pilot green deposit program in July 2021, totaling $85 million as of Sept. 30, 2021.

Aspiration (Marina Del Rey, California)
Fintech introduced Aspiration Zero Credit Card, earning cash back rewards and planting two trees with every purchase.

JPMorgan Chase & Co. (New York)
Designated “Green Economy” team to support $1 trillion, 10 year green financing goal.

Bank of America Corp. (Charlottesville, North Carolina)
Increased sustainable finance target from $300 million to $1.5 trillion by 2030.

Fifth Third Bancorp (Cincinnati, Ohio)
Issued $500 million green bond to fund green building, renewable energy, energy efficiency and clean transportation projects.

 

Boards that don’t address climate change as a risk in the boardroom will likely overlook strategic opportunities. “Banks that are poorly prepared to identify climate risks will be at a competitive disadvantage to their better-prepared peers in seizing those opportunities when they arise,” Hsu said.

Hsu offered two additional questions for bank boards in his speech. “How exposed are we to a carbon tax?”references the price the U.S. government could place on greenhouse gas emissions; however, he also stated that the passage of such a tax in the near future is unlikely. The other, “How vulnerable are our data centers and other critical services to extreme weather?” certainly warrants attention from the board and executive team as part of any bank’s business continuity and disaster recovery planning.

Most management teams won’t be able to answer broader, strategic questions on climate initially, Hsu said, but that shouldn’t keep boards from asking them. “Honest responses should prompt additional questions, rich dialogue, discussions about next steps and management team commitments for action at future board meetings,” Hsu stated. “By this time next year, management teams hopefully should be able to answer these questions with greater accuracy and confidence.”

2021 Risk Survey Results: High Anxiety

An outsized crisis requires bold action. The banking industry responded in kind when the economy spiraled as a result of the Covid-19 pandemic.

Financial institutions across the country assisted small businesses by issuing Paycheck Protection Program loans. Banks also almost universally modified loans to help borrowers weather the storm, according to Bank Director’s 2021 Risk Survey, sponsored by Moss Adams LLP. At the peak of the downturn, 43% of the directors, CEOs, chief risk officers and other senior executives responding to the survey say their bank modified more than 10% of the loans in their portfolio.

Conducted on the heels of a tumultuous 2020 — with the pandemic, social strife and political change continuing into January — the survey reveals high levels of anxiety across the risk spectrum. In particular, respondents indicate greater unease regarding cybersecurity (92%) and credit (89%), as well as strategic (62%) and operational (52%) risks.

Almost half of respondents indicate that some or most of the loan modifications extended into the fourth quarter 2020, and two-thirds reveal concerns about concentrations in their loan portfolio, with most pointing to commercial real estate (43%) and/or the hospitality industry (31%).

Forty-three percent indicate that their bank tightened underwriting standards during the downturn. Looking ahead, many are unsure whether they’ll ease their standards to lend to business customers in 2021 and 2022. The challenges to bankers have been deep during the past year.

As the CEO of a small, southeastern community bank put it: “What doesn’t kill you makes you stronger.”

Despite this uncertainty, bankers express some optimism. More than three-quarters believe that supporting their communities during the pandemic has positively affected their bank’s reputation. Eighty-seven percent expect fewer than 10% of their bank’s business customers to fail. And 84% will improve their bank’s business continuity plan due to what they’ve experienced.

Key Findings

More Robust Stress Testing
More than 80% say their bank conducts an annual stress test. Of these, 60% have expanded the quantity and/or depth of economic scenarios examined in response to the Covid-19 pandemic.

Cybersecurity Gaps
Sixty-three percent say their institution increased its oversight of cybersecurity and data privacy in 2020. Most say the bank needs to improve its cybersecurity program by training staff (68%) and implementing technology to better detect or deter threats and intrusions (65%).

Pandemic Plans Adjusted
Respondents identify several areas where they’ll enhance their business continuity plan as a result of the pandemic. The majority point to formalizing remote work procedures and policies (77%), educating and training employees (56%) and/or providing the right tools to staff (55%). Roughly half say that fewer than a quarter of employees will work remotely when the pandemic abates; 25% say that no employees will work remotely.

Banking Marijuana
Forty-one percent of respondents represent a bank headquartered where marijuana use is at least partly legal. Overall, one-third are unsure if their bank would be willing to serve marijuana businesses. Just 7% serve these businesses; 34% have discussed banking this industry but don’t work with these companies yet.

Climate Change Still Not a Hot Topic
Just 14% say their board discusses the risks posed by climate change at least annually; this is up slightly from 11% in last year’s survey. Fewer than 10% say an executive reports to the board about the risks and opportunities that climate change presents to the institution.

To view the full results of the survey, click here.