Webinar 7

Webinar presentation: How banks assess climate risks and integrate them into credit risk assessments

The EIB West and Central Africa SME Banking and Microfinance Academy 2022

Webinar series – Learning event

Topic 7:  How banks assess climate risks and integrate them into credit risk assessments 

24 March 2022, 01 pm GMT (Abidjan) / 02 pm (Cotonou, Paris, Frankfurt, Douala, Kinshasa)/ 03 pm (Lusaka, Harare, Johannesburg) / 04 pm (Addis-Ababa, Nairobi)

The seventh in a series of webinars organized by the EIB Academy dedicated to SME finance banks and microfinance in West and Central Africa, in partnership with Making Finance Work for Africa (MFW4A), was held on March 24. Its theme was “How banks assess credit risks and integrate them into credit risk assessments.”

The audience was that of the big days with about 234 participants, which reflects the importance of this theme, given the impact of climate risks on the global economy and particularly African. After the opening remarks by Jane Feehan, Head of the European Investment Bank delegation in West Africa with residence in Abidjan, the moderator, Carina Dunker, Director of Green Finance at IPC, set the context.

From the outset, she stated that the climate is changing and we must adapt to these changes. The goal is to keep the global temperature increase below 1.5 degrees Celsius to transition to a zero carbon society. The financial sector plays an extremely important role in addressing physical and transition risks while integrating them into its assets and operations.

Gerhard Mulder, climate finance expert and co-founder of Climate Risk Services (CRS) spoke about why climate risk is important for financial institutions. He distinguished between environmental and social materiality, which relates to the impact of the company on the climate, and financial materiality, which relates to the impact of the climate on the company. Climate change presents risks and opportunities. Opportunities for the company but also for the planet if the products and services contribute to climate adaptation and mitigation. The risks for the company are related to the increase in climate risks such as extreme storms, heat stress, as well as increased regulation. According to Larry Fink, the CEO of Blackrock, a leading investment management firm, climate risk is an investment risk. The fundamental question is what is being done to mitigate these risks? The Bank for International Settlements (BIS) has stated that climate risk needs to be rethought because previous approaches are inconsistent with the uncertain forward-looking nature of climate risks. We need to understand the difference between physical risk and transition risk and the trade-off between the two.  Either we invest in climate change mitigation today to prevent the worst physical impacts with the result of high transition risk today but less in the future, or we do not invest in mitigation today and in turn this will give low transition risk today but high physical risk in the future. It is also likely that we will see the worst of both, as sudden policy shocks that occur only after significant physical risk are already locked in.

The second speaker, Hermann Comoé, agronomist, and expert in physical climate risk presented the perspective of physical climate risk and financial institutions. In Africa, agricultural productivity growth has been reduced by 34% since 1961 due to climate change. Warming of the atmosphere will negatively affect food systems in Africa by shortening growing seasons and increasing water stress. Climate warming greater than 2° Celsius will result in lower yields of staple crops and tree crops in most of Africa compared to 2005 yields. Physical climate risk assessment in the agricultural lending sector is done using two approaches: In the first approach, the financial institution uses a scorecard and portfolio analysis tool. Banks first assess all vulnerabilities at the country level such as gradual changes in temperature or precipitation and/or acute changes such as hazards and then at the portfolio level by analyzing client data such as repayment capacity or cash flow. The second approach is to integrate a climate standard into the financial institution’s environmental and social management system. These are primarily policies and procedures put in place to identify, measure, and manage environmental risks and integrate them into daily operations. The practitioner also identified other adaptation and mitigation measures that may require the services of a financial institution. Lessons learned included the relevance of climate and crop simulation models with high quality and quantity of input data. Increasingly, banks are opting for meso-level insurance solutions to protect their agricultural portfolios from climate risks or are requiring farmers to purchase insurance to obtain a bank loan.

Marc Daubrey, expert in climate finance and Managing Director of Green Invest Africa addressed three angles, namely the risk-climate-credit triptych approach from the point of view of the green or greening SME, the challenges or realities on the ground from the point of view of the perception that banks have of green or greening SMEs, and finally the potential solutions In Côte d’Ivoire, SMEs play an important role in the economy accounting for more than 80% of the country’s economic activities. The Green Invest approach is to take into consideration the climate-finance nexus. If we talk about the climate risk which is real, we must also talk about climate activities and sectors, as well as access to finance which allows to accelerate and capitalize on opportunities.  Usually, banks’ internal analyses are based on an ESM approach. This is very relevant in assessing climate risks, but banks also look at green or greening SMEs from a customer relationship perspective. Furthermore, as mentioned above, the idea is also to identify the main economic sectors in which green SMEs operate. In West and even Central Africa, the priority sectors are firstly agriculture and forestry, then energy, with renewable energies and transport at the forefront, and finally the waste management sector. In the field, the banks say that the elements of analysis are of course technical risks such as credit, market liquidity and operational risk. More and more banks are taking into consideration environmental and social risks. In addition to this, there is the classical analysis which consists in examining the traditional criteria for granting loans, such as the repayment capacity, the debt ratio and the competitive analysis. In conclusion, the more banks know about the operating mode of green SMEs and their sectors of activity, the better. For its part, Green Invest Africa also tries to provide solutions to enable banks to move forward and facilitate access to financing for green SMEs.      

After an exchange session with the participants, the panelists shared some concluding messages, highlighting the importance of climate risks and their impact on financial institutions.

The webinar concluded on this note.