Banks’ new headwinds: Transition risks of low – carbon economy

Apart from price volatility, which could trigger defaults from the oil and gas sector, transition to a low carbon economy could
prove fatal to most banks, as risk related to such a move remains elevated, a careful examination of emerging developments by business a.m. has shown.

According to the National Bureau of Statistics (NBS), the total exposure of Nigerian banks to the sector, which is threatened by a global movement for low carbon via renewable energy, amounted to N3.58 trillion or 22.74 percent of the N17.74 trillion allocated by banks to the private sector in Q4 2017.

The overexposure of banks to a sector having challenges in price and production as well as a negative perception of it contributing to the greenhouse effect is worrying, say analysts spoke to by this newspaper.

Though the sector appears to have weathered the storm of the 2015 price collapse and has responded with considerable accomplishments, the industry faces considerable headwinds from external challenges to its future, including negative public perceptions of its contributions to greenhouse gas emissions and global warming.

Increasingly, natural gas is less unpopular than oil, according to research conducted by EY, but renewables are overwhelmingly now preferred by adults and teens alike.

Again, the emergence of battery electric vehicles (BEVs) as viable, albeit expensive competitors to internal combustion engines, has been abetted by remarkable improvements in battery performance.

Decarbonization policies, either in mandates and subsidies for renewables, cap-and-trade or a carbon tax, are also helping to close the gap between the cost of renewable power and the cost of power from natural gas and oil, all helping to make the oil and gas industry future nebulous and fragile.

Despite the obvious threats and growing nonperforming loans from the sector, Nigerian banks are still steep in oil credits.

In other climes, major central banks have seen the challenge and have called for concerted action on climate change.

Mark Carney, governor of Bank of England and Francois Villeroy de Galhau, governor of the Banque de France have called for action by financial experts to deal with the risks of climate change, at the first conference hosted by a high-level group of central banks and super visors dedicated to the subject.

The Central Banks and Supervisors Network for Greening the Financial System, or NGFS, held its inaugural international climate risk conference for supervisors at the Netherlands Bank on April 6.

Frank Elderson, executive director of the Netherlands Bank heads the group, which was launched in December, comprising the People’s Bank of China, the Bundesbank as well as BaFin,

Banque de France and its twin authority the Autorité de Contrôle Prudentiel et de Résolution (ACPR), the Bank of England, Netherlands Bank, Bank of Mexico, the Swedish Financial Services Authority and the Monetary Authority of Singapore.

Villeroy de Galhau, governor of the Banque de France, said the financial system had to both prepare for risks from climate change and assist a transition to a global economy that used lower amounts of carbon. Physical risks caused by extreme climate events were “the most visible and immediate source of risk for the financial sector”, and were rising rapidly.

“Transition risks” related to the costs of moving to a low-carbon economy were “less visible” and “have not yet materialised”, Villeroy de Galhau said, arguing that ignoring them would be a serious mistake.

“Transition costs and uncertainties about the winners and losers will certainly create strong market volatility and lead to adverse aggregate macroeconomic outcomes,” he said.

On the other hand, physical risks caused by extreme climate events were “the most visible and immediate source of risk for the financial sector”, and were rising rapidly. The ACPR estimated “13% of French banks’ total net credit exposure is to sectors vulnerable to transition risks”, he said.

Villeroy de Galhau called for several reforms, with the first priority being to identify and disclose existing exposures to climate change-related risks in the financial sector, producing a “snapshot of risks”.

Central banks and supervisors should identify best practices for disclosing these risks in Europe, and then move towards making them compulsory for financial institutions, he said.

The NGFS would be evaluating how to use climate change scenarios in supervisors’ stress tests, he said. It would also look at how shocks would have an impact on default probabilities “over a much longer horizon than the usual one of one year”.

The French apex bank governor also said there needed to be a broader and more innovative green financing market, with “green securities” and “green debt” alongside “green bonds”. The fact that the latter were usually over-subscribed indicated the market for financing the shift to a lower-carbon economy could be considerably larger, he said. business a.m. spoke to a risk expert in one of Nigerian banks who said banks and the regulator are aware of the risk to the sector aside volatility in oil prices and the dwindling demand in the future for oil, which they have factored in their risk planning.

On the rising exposure to the oil and gas sector, he said despite a long list of growing non-performing loans from
the sector, it is still viable for business,hence the exposures.

“If we are not making money fromthe sector we would not have committed much funds to it,” he said.

However, business a.m. learnt that transition to the low carbon economy would make carbon industry such as oil
and gas less attractive, thereby result in reduced investments and earnings.

To this end, the banks and the financial services industry are urged to work out a risk mitigation plan for the industry regarding climate change.