Knowledge and Insights

Risks You Haven’t Thought of: How Climate Change is Presenting New Challenges for Lenders

In the Fourth Quarter of 2021, President Biden presented his administration’s “roadmap for climate change,” identifying how government agencies would strengthen infrastructure in response to worsening climate conditions. This was a key position during the Biden campaign, and its persisting emphasis has brought the world of banking to an inflection point. Climate Plan B impacts taxes, regulatory environments, and actions both at the federal and state levels. For financial institutions that lend money, there are new dynamics to consider.

Climate change considerations raise two relevant questions: 

  • What is the impact of the bank?
  • What is the impact to the bank?

The first of these is addressed through statements that clearly define a bank’s approach to reducing environmental impact from an operational perspective.

Social Stances and Statements

Every business in the country is publishing statements and launching initiatives dedicated to causes like carbon neutrality and emissions reduction. Consumer perception is quantifiably impacted by climate change, and surveys indicate that sustainability and environmental claims are a key factor for business affiliations and purchases. Banks of all sizes need to attract the increasing purchasing power of Generations X through Z, and genuine attempts to be environmentally conscious are a part of that. What’s more, banks that rely on capital from external parties may encounter increasing pressure from investors to issue a stated dedication to environmentally conscious practices.

For many small or midsize lending institutions, the more pressing issue is to answer the question of “what is the impact to the bank?” Risk analysis is the best approach to answering that salient question.

New Metrics for Analyzing Credit Risk

As the regulatory environment continues to shift, new compliance frameworks will emerge. Stress testing portfolios for climate risk is not yet required by the federal government, but it is an important exercise that will uncover areas of concern. For example, many banks served by Mercadien operate in the northeastern part of the United States, an area that has been hard hit by flooding in the last year. These natural disasters could affect any customer, but those in manufacturing or shipping may be at a higher risk to lose repayment ability if their facilities are damaged. Additionally, for businesses directly affected by climate change, regulations may change. There may be a cost associated with compliance measures, which could indirectly stress a portfolio and, consequently, impact the borrower. 

Impact risk analysis will make it clear what types of risks the average client is facing, and how a bank can mitigate that risk.

Here is what the experts at Mercadien envision:

  • Short-term impacts over the next five years necessitate ongoing internal impact risk analysis: banks need to carefully review portfolios and customers, and stay informed about new initiatives, legislation, and regulations. If specific industries are dramatically impacted, they may need expert analysis for comprehensive review and impact estimates.
  • Long-term impacts over the next ten years will likely include entirely new standards of doing business. Even small lending institutions will be affected, and the expectation will be that every company operates with a protocol related to environmental impact.

Leading the Change

Industry leadership is always important, and banks of every size have an opportunity right now to be drivers of change. Many times, regulators will see the dynamics that occur and shape policies accordingly. Whether climate change appears to be something imminently or eventually relevant to your business, the time to pay attention and adapt is now

For guidance through this season of change, the team at Mercadien is well-equipped and standing by. We are making every effort to stay in the know and on the cutting edge of these shifting dynamics, and helping our clients make strategic choices that will place them at the forefront of key changes industry-wide. Contact us to learn more.

DISCLAIMER: This advisory resource is for general information purposes only. It does not constitute business or tax advice and may not be used and relied upon as a substitute for business or tax advice regarding a specific issue or problem. Advice should be obtained from a qualified accountant, tax practitioner or attorney licensed to practice in the jurisdiction where that advice is sought.