Banks start dropping clients to dodge costs tied to ESG risk

[COPENHAGEN] European banks are beginning to drop clients that pose a climate risk rather than face the possibility of higher capital requirements, the watchdog overseeing the development has said.

Banks are raising prices, denying loan requests, "de-selecting industries and in some cases, clients," said Jacob Gyntelberg, director of the economic and risk analysis department at the European Banking Authority (EBA). There is already evidence that upstream oil and gas projects are falling out of favour as banks move beyond coal exclusions.

This comes amid growing pressure on the finance industry from regulators and investors to shift over to low-carbon intensity sectors. At the same time, sectors judged to be at the receiving end of climate change - including some corners of the mortgage market - are also being reassessed by banks, the EBA said.

Once viewed as a measure of last resort, the deleveraging comes as the financial sector faces historic requirements to address environmental risks. European lawmakers want to redirect the flow of capital away from industries that pollute, amid unequivocal signs that climate change is already proving deadly and as scientists warn that time is running out.

In a report on Monday, Moody's Investors Service warned that banks' loan losses could soar 20 per cent under the most extreme climate scenario. "Climate risk is likely to have a major influence on banks' loan quality, and depending on how climate change unfolds, and on the policy response to it, the losses that ensue could be substantial," Moody's said.

In the lead-up to the COP26 climate talks in Glasgow next month, banks are expected to provide more ambitious statements on cutting their CO2 footprints in updated net-zero carbon emissions goals.

A separate report in May to the European Commission found that while most lenders are trying to figure out how to measure the financial risk of environmental, social and governance factors, few have gotten very far. And while the focus for now is on climate, work on regulating the other two elements in ESG investing is progressing.

The EBA is working with national supervisors and the industry. There is a fundamental shift under way in how banks do business, and Mr Gyntelberg said his agency is seeing some "encouraging" signs.

Autos and leasing banks are also "making more clear distinctions across the auto loan book, they are making more clear distinctions in the leasing books, they are making more clear distinctions in mortgages," he said in an interview.

"They are looking at sectoral differentiation when it comes to pricing, and they are even saying no." Rising temperatures and the sweeping changes that governments and industries are pursuing to mitigate them, present risks to the financial industry in the form of falling collateral values to bankrupt clients. But loan books are where the industry's vulnerability to a transition to a carbon-free future may be the greatest.

Moody's Investors Service notes that loans account for two-thirds of the US$22 trillion in exposures that the biggest global banks, asset managers and insurance companies have to carbon-intensive industries with the least certain futures.

At the same time, banks have to make good on commitments to help achieve the Paris Agreement, amid pressure from investors to do more to hold temperature increases in check.

BLOOMBERG