Global warming heats up risk management

When we think of risk management within a financial institution, we usually associate it with the operational risks related to fraud, money laundering, damage to reputation, etc. But an interesting article recently reminded me that risk presents itself in many forms…including ones that banks must have the foresight to control, such as mitigating the impact of global warming.

A recent report by Canada’s Shareholder Association for Research & Education (SHARE) suggests that banks need to establish a climate change strategy that allows for them to recalibrate risk management quickly as the earth’s surface temperature rises. Why is this important? Because banks are vulnerable to the economic, social and political impacts that are caused by global warming.

For example, financial institutions are usually heavily invested in energy sector, including fossil fuels. As global warming increases, fossil fuels become a less-viable energy resource – increasing the bank’s exposure to risk in carbon-related assets.

Climatic change can also affect a financial insitution’s real estate investments, sometimes in very surprising ways. Warmer temperatures lead to an increase in the number of damaging storms, and while today’s building codes require developments to use materials made to withstand wind, they are usually less resilient to flooding. As temperatures rise, banks need to take into account the changing value of assets located in exposed areas, particularly those along coastlines and other waterways. This may cause a financial institution to proactively alter the geographic location of its asset portfolio to mitigate risk.

According to the World Economic Forum, climate change is a major long-term threat to investment and economic security. In fact, industry observers note that if the world’s largest asset owners (including pension funds and insurance companies) don’t change their risk strategies to correct the imbalance between high and low carbon investments, it could precipate another global financial crisis similar to the one in 2008.

With so many potential risks, including those that come from unexpected natural causes such as global warming, banking institutions today are forced to rely even more heavily on technological advancements to help them navigate the financial waters. It’s a brave – and warmer – new world in the development of financial risk management strategies.