Column by Maxim Builov on climate risks for the banking sector

This week, the Bank of Russia unexpectedly published detailed recommendations for financial institutions on taking into account climate risks. Next year, the regulator plans to prepare recommendations “how to take such risks into account in internal procedures for assessing capital adequacy.”

The authors of the document divide climate risks into physical and transitional. Physical represents the probability of losses associated with natural hazards arising from climate change. Transition risks are associated with possible losses from the transition of foreign counterparties to an economy with low greenhouse gas emissions.

Everyone in the banking market knows that the recommendations of the Central Bank, like it or not, must be followed. Specifically with climate issues, everything is both simple and complex. The fact is that, according to the authors of the document, “the current loss from hazardous phenomena is poorly estimated, which complicates the further calculation of physical risk.” Moreover, “humanity has not yet encountered many of the potential impacts of climate change or collected and stored the necessary indicators.” In short, assessment and transformation into traditional risks “is usually difficult due to a lack of data.”

To combat climate uncertainty, the regulator proposes, firstly, to conduct stress testing and use scenario analysis. That is, employees can model climate change and virtually overcome emerging risks. And secondly, build a monitoring system for “significant and potentially significant risks.”

To avoid misunderstandings, the recommendations note that small financial organizations can use the resources of news agencies, research institutes and publicly available information to reduce costs. Moreover, bank boards of directors are encouraged to review the results of climate risk assessments at least once a year, and it is better to create separate committees to monitor them.

In general, if you get creative, you can build a cyclopean structure that will track everything from the characteristics of the Gulf Stream to greenhouse emissions in Pakistan. If we approach it pragmatically, the bank can instruct an analyst, who is obliged to monitor the ESG agenda, to also make a report on climate risks for the board of directors once a year. The probability that climate risks will materialize in both cases, as the blonde from the joke aptly put it, is 50 to 50.