Credit exposure to climate change

The European Central Bank and the Bank of Spain are aware of the climate change threat. They have also identified the environmental issue as one of the main risks in the financial sector.

There are two reasons behind this sentiment: the first is the increase in weather catastrophes that decrease the value of the affected assets. However, there is a concern that these “Green New Deals” will hurt local investment portfolios.

Those responsible for supervision and analysis of the Spanish regulator have intensified their contacts with the main entities in the country to ask them to detail their exposure to this risk, explain sources close to the public body headed by Pablo Hernandez de Cos.

The aim is to improve the very limited database that the regulators handle in this area. They also mean to improve its  “green risk measurement” in future reports.

The double threat to climate change

In its latest financial supervision report, the Bank of Spain warned of the double threat that climate change poses to the balance sheets of financial institutions.

On the one hand, the increase in the frequency and intensity of climatic events such as droughts, floods or storms could lead to higher costs for the insurance companies of affected families and for the banks of those that are not covered.

On the other hand, the regulatory measures adopted to meet the European pollutant emission reduction targets will drive some industries with high exposure to bank financing out of the market.

In Spain, for example, the entire coal industry will be forced to close before 2021 because of the increase in CO2 emission rights and the energy transition plans submitted by the government to the European Commission.

Last June, the ECB estimated the exposure of the European financial system as a whole to the energy transition at $794.48 billion (€720 billion). Of this figure, according to his estimate, $55.16 billion (€50 billion) would correspond to bank loans, which is around 3% of the portfolio.

However, sources close to the Bank of Spain explain that this is merely a round calculation that will now have to be fine-tuned by the supervisory teams.

Risk criterion

However, these first meetings have not been very fruitful for the regulator because the banks respond that they do not have the necessary instructions to measure this risk criterion. There is a lack of concrete regulation at the European level to assess climate risks on bank assets.

“It is not an easy task and requires overcoming numerous obstacles and barriers. These include the lack of public information from companies and financial institutions.

Also, the lack of development of methodologies that incorporate climatic, macroeconomic and financial aspects and their interactions,” explained recently the Councillor of the Bank of Spain, Soledad Núñez, in a Federal report confirmed with the economist of the regulator Clara I. González.

But climate change, far from being just a threat to the financial sector, can be a huge business opportunity for entities. Botín herself stressed to the bank’s managers the need to multiply by four in the next decade the ‘green’ funding granted to companies responsible for the environment, reaching $22 billion in 2030.

This figure would be equivalent today to a quarter of the entity’s credit portfolio.

The problem, according to the banking regulator, is that ‘green’ funding is currently very limited to large industrial and financial corporations because of their ability to link fundraising to sustainable projects.

Its issuance has grown exponentially in recent years, rising from $11 billion to $168 billion a year globally between 2013 and 2018. In the first half of 2019, emissions exceeded $120.25 billion (€109 billion).

However, SMEs, which account for most of the business loan portfolio, have difficulty accessing these loans. “The demand for green instruments will also benefit as issuers publish relevant and harmonized financial information on climate change risks and policies,” explains Núñez.

The marijuana industry is not a threat to the financial sector

In accordance with the fact that ‘green’ funding has grown in recent years from $11 billion to $168 billion a year, similar growth is expected from medical cannabis. Cannabis is already legal as a treatment in most European and North American jurisdictions.

Medical cannabis is becoming increasingly popular as an alternative to opioid-based pain management solutions.

The European medical cannabis market is expected to double in size over the course of 2019 and be worth $123 billion by 2028. Both cannabis investors and funding investors are beginning to view medical cannabis as a key growth area.

That being said, it is a complicated market and cannabis investment tools like Hemp.IM is key for both experienced and new investors in this dynamic sector.

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(Featured image by Li-An-Lim via Unsplash)

First published in Economia, a third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

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