1、Climate-related perils are on the riseboth threatening banks loan portfolios and offering new business opportunities.By Camille Goossens,Rocco DAcunto,Ghizlene Azira,and Aude SchonbachlerFires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksCopyright 2023 Bain&Company,Inc.All rights

2、 reserved.1Fires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.At a Glance Wildfires,droughts,and other climate-related perils threaten banks loan portfolios,yet many have only a general sense of their vulnerabilities.We expect real estate ass

3、ets exposure to physical risk to rise over the next couple of decades,likely reducing the value of collateral and damaging banks mortgage business profitability.Banks that take the right steps soon could improve their financial stability,customer retention,and compliance with emerging regulatory sta

4、ndards.Measuring physical risk requires new tools,capabilities,forecasting horizons,and dataall of which have been challenging to source and embed.As if banks dont have enough to worry about with high inflation and the recent turmoil around liquidity and long-term assets,now,another risk looms incre

5、asingly largenamely,the destructive power of the natural world.High winds,floods,and other hazards pose significant threats to real estate assets and more broadly to the productivity of businesses within banks portfolios.To better understand the risks and trends accompanying these perils,Bain&Compan

6、y analyzed data provided through a unique strategic partnership with climate risk analytics firm Jupiter Intelligence.Banks have begun to understand their climate risks,in part because regulators are starting to probe the vulnerabilities of portfolios risk through climate stress-testing.But few bank

7、s have holistically quantified their physical risks by business or industry using forward-looking data and scenario-based modeling,as opposed to historical data.Even fewer have taken steps to mitigate the risks.Given the continued housing and commercial development in harms way,banks need to get mor

8、e rigorous about addressing climate-related physical risks.Perfect stormsSince the middle of the last century,climate-related perils have been growing worldwide in number and intensity,the World Meteorological Organization reports,a pattern consistent with rising carbon dioxide emissions and tempera

9、tures.Human settlement and economic activity,meanwhile,continue to expand along seacoasts and other vulnerable areas.2Fires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.Financial regulators globally have taken notice and increasingly ask for

10、more accountability on physical risk measurement.The European Banking Authority,for instance,now requires banks to carry out scenario analyses on how such risks could affect the loan portfolio.Yet banks are only now starting to incorporate physical risk into their business models.Bain analyzed the t

11、op 50 banks globally(by total assets)that currently adhere to the Financial Stability Boards Task Force on Climate-Related Financial Disclosure.Bain found that in Europe,only 18%of those banks have begun to integrate physical risks into their business strategy.Sizing the exposureThe data and tools a

12、vailable to help measure and understand the extent of various physical perils and their economic costs have become more reliable.Financial losses range from crop failure to damaged infrastructure to business and employment interruption.Bain used Jupiter Intelligences data to assess the extent of phy

13、sical risk exposure over a 30-year horizon in any country,down to individual properties in a neighborhood.Jupiter measures physical risk across eight perils:flood,precipitation,wind,heat,wildfire,hail,drought,and cold.Based on a score that synthesizes those perils,Jupiter assigns a risk intensity to

14、 the region.Physical risk affects banks mainly in two ways.First,it damages collateral,such as a house or factory,and reduces its value.Second,it impairs and may lead to the insolvency of counterparties because of a loss of production and creditworthiness.Consider how much territory falls in the hig

15、h-risk categorynamely,a territory where an extreme event such as a hurricane or flood has a high probability of occurrence.As an example,Jupiter categorized 43%of the US,63%of Australia,and 31%of Indonesia as high risk.For all countries assessed,physical risk increases over time(see Figure 1).In Ger

16、many,33%of the territory is exposed to high physical risk today,a level expected to double by 2050.In Brazil,the extent of high-risk territory will likely triple by 2050,to 74%.In sum,physical risks are already widespread and will grow worse.3Fires,Floods,and Loans:How Banks Can Deal with Increasing

17、 Climate RisksJupiter Intelligence|Bain&Company,Inc.Physical risk affects banks mainly in two ways.First,it damages collateral,such as a house or factory,and reduces its value.Second,it impairs and may lead to the insolvency of counterparties because of a loss of production and creditworthiness.For

18、example,crop failures caused by drought or flooding could expose an agribusiness to losses that make it difficult to repay a loan.Of course,any single natural hazard will have a different degree of impact on each country or industry in a banks portfolio.Banks will also want to assess different outco

19、mes of an event,whether those are physical damages,rising energy costs,or business interruptions.Exposure of a mortgage portfolioTo illustrate the potential effects of climate events on the banking sector,Bain analyzed a sample mortgage portfolio of 10,000 assets in Italy,using Jupiter data.We asses

20、sed the current and expected future physical risk exposures for all eight perils across UN climate panel scenarios that range from carbon dioxide emissions cut severely to reach net zero after 2050(Shared Socioeconomic Pathway Figure 1:Physical risks are expected to increase in every countryNote:Per

21、ils included are flood,precipitation,wind,heat,and wildfireSource:Jupiter Intelligence Percentage of land subject to risk of physical perilsUSGermanyItalyIndonesiaAustraliaBrazilToday2030205068%38%33%97%38%31%43%45%65%63%65%73%62%50%40%74%37%25%MediumLowHighToday203020504Fires,Floods,and Loans:How B

22、anks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.1-2.6,SSP1-2.6)to emissions that hover around current levels before starting to fall midcentury(SSP2-4.5)to emissions that roughly double by 2050(SSP5-8.5).Across Italy as a whole,40%of these sample locations are alread

23、y highly exposed to at least one natural hazard today,a level expected to rise to 62%by 2050,which highlights the need for a comprehensive physical risk data set.The assessment reveals how quickly a mortgage portfolio can become exposed to high levels of risk related to one hazardin this case,fire,t

24、aking into account factors such as fuel availability and local fire suppression(see Figure 2).When the effects are combined with those of flood and drought risks on our sample portfolio,our analysis shows that damages could be as high as 10 to 15 percentage points of the value of collateral,and pote

25、ntially much higher for assets in very high-risk areas.The damage could then worsen already eroded margins via a 7-to 10-percentage-point reduction in the profitability of newly originated mortgages over a 10-year period.The magnitude of this hit to profits raises the stakes for banks to clearly und

26、erstand how physical risks can affect their portfolios.Figure 2:In Italy,twice the number of assets will be exposed to high risk and three times more assets exposed to very high risk of fire by 2050Source:Bain analysis of Jupiter Intelligence dataPercentage of total portfolio of 10,000 assets expose

27、d to fire risk2050TodayVery high riskHigh risk2.2%18.5%7.0%34.7%5Fires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.Developing a sound strategyThis type of analysis is essential for developing a sound strategy that combines mitigation measure

28、s with opportunities for new business.Defensive tactics.The analysis first informs decisions on how to mitigate risks through defensive tactics such as:imposing loan-to-value caps;shifting the mix of customer segments;reducing the cost of risk through credit protection insurance;and adjusting prices

29、 on highly exposed areas.Defensive tactics could be worth 5.5 percentage points in net operating income to the mortgage portfolio of a bank.Offensive tactics.Beyond the defensive stance of mitigating risks,banks can take a more offensive posture by,for instance:raising discount levels on low-risk as

30、sets;pushing for credit protection insurance;and standalone climate risk protection insurance.Offensive moves could add an additional 5.3 percentage points in net operating income.New offerings.Banks can also create a competitive advantage by developing new financing products and advising clients to

31、 help them make the transition.New risk-related business opportunities could include the following:fostering and financing adoption of climate adaptation solutions;promoting public-private partnership financing in cities and towns;and offering assessment of the physical risk resiliency of corporate

32、assets and facilities.This set of new business moves could further add 10 percentage points to net operating income.6Fires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.In sum,combining mitigation measures with value creation moves could yield

33、 a 15-to 20-percentage-point(or more)increase in net operating income in 2030.Moreover,taking limited or no action will have more severe consequences over time(see Figure 3).Becoming a first mover or fast followerIts high time for banks to integrate physical risk into risk,credit,and strategic plann

34、ing processes.This entails updating credit rating assessment and policies as well as collateral analysis to reflect physical risk,adapting client onboarding to capture key risk-related information,and incorporating the risks into customer segmentation to ensure a consistent treatment of physical ris

35、k across the bank.A shift in strategy to incorporate the realities of physical risk will require banks to continuously experiment and anticipate market responses,adapting their business model as necessary.But any tactic will have reputational and regulatory implications that need to be considered al

36、ong with the economic effects.Figure 3:As physical risks increase,banks should adopt a mix of defensive and offensive tactics while also pursuing new business opportunitiesNote:Bar totals are roundedSource:Bain analysis of Jupiter Intelligence dataPercentage point change in net operating income of a

37、 sample mortgage portfolio over a 10-year periodNetoperatingincome(after noaction)91.5Playdefense5.5Netoperatingincome(after playdefense)97.0Playoffense5.3Netoperatingincome(after playoffense)102.2Playto win10.1Netoperatingincome(after playto win)112.4100%Netoperatingincome8.5No actionUnderwriting,p

38、ricing,andConsumerPrice IndexPricing andstandaloneinsuranceAdaptation financeand advisoryservices across the bank7Fires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.A bank can start by assessing its portfolio to measure peril-specific exposur

39、e and identify the hot spots most relevant to the specific asset class and industry assessed.Based on the mix of perils in a portfolio,the bank can identify an initial set of mitigation tactics in line with market conditions,regulatory constraints,and the banks overall strategy.Depending on its ambi

40、tions,it could then also identify openings for new peril-related products and services that create value while strengthening clients and communities against climate-change effects.Physical risk represents a major threat,to be sure,but also a unique opportunity for innovation in the banking sector.Am

41、bitious banks that move soon to take the right steps could improve their financial stability and perception among customers and regulators.Even if a bank does not have the appetite or capabilities to be a first mover in this regard,it pays to start planning now,as its impossible to become a fast fol

42、lower without early preparation.8Fires,Floods,and Loans:How Banks Can Deal with Increasing Climate RisksJupiter Intelligence|Bain&Company,Inc.For more information,visit Bold ideas.Bold teams.Extraordinary results.Bain&Company is a global consultancy that helps the worlds most ambitious change makers

43、 define the future.Across 65 cities in 40 countries,we work alongside our clients as one team with a shared ambition to achieve extraordinary results,outperform the competition,and redefine industries.We complement our tailored,integrated expertise with a vibrant ecosystem of digital innovators to d

44、eliver better,faster,and more enduring outcomes.Our 10-year commitment to invest more than$1 billion in pro bono services brings our talent,expertise,and insight to organizations tackling todays urgent challenges in education,racial equity,social justice,economic development,and the environment.Abou

45、t Jupiter IntelligenceJupiter Intelligence is the trusted leader in climate risk analytics for organizations looking to strengthen their climate resilience.With forward-focused,rigorous methodologies and analytics delivered by some of the best scientists in the industry,Jupiter turns sophisticated climate science into actionable data.Customers proactively assess the physical risks within their portfolios,address regulatory requirements,and evaluate potential reputational concerns.To find out more,visit