Australia’s largest banks predicted that they would adjust their risk appetites and lending practices in response to increasing climate-related losses, with potential actions including cutting back on high loan-to-valuation mortgage lending, and reducing exposure to sectors such as mining, manufacturing, and transport), according to a new study released today by financial services regulator, the Australian Prudential Regulation Authority (APRA).

ARPA conducted its first Climate Vulnerability Assessment (CVA) with the country’s five largest banks – ANZ, Commonwealth Bank, Macquarie Bank, National Australia Bank and Westpac – which modelled the estimated future financial impact of climate change on their businesses, and their potential responses to physical and transition climate risks.

The participating banks based their analyses on two scenarios developed by the Network for Greening the Financial System (NGFS), which reflect a range of possible future climate policies, physical risks, including heat, drought and floods, and short and long-term risks stemming from the transition to a greener economy such as increasing carbon prices. The scenarios included a Delayed Transition Scenario with delayed policy action on climate change, followed by a rapid reduction in global emissions after 2030, and a Current Policies Scenario representing a future with continued increase in global emissions beyond 2050.

The study found that while the climate risks under the scenarios studied were unlikely to lead to severely impact the banking system, banks could experience increasing losses from their lending portfolios from physical and transition risks in the medium- to long-term.

APRA Deputy Chair Helen Rowell said:

“The results suggest that banks’ losses from their lending portfolios could rise in the medium- to-long-term as climate change and the global response to it unfolds. Although those impacts are not expected to cause severe stress to the banking system, climate change could lead to the banking sector being more vulnerable to future economic downturns.”

Within business lending, both scenarios were found to result in a substantial increase in losses arising from transition risks, with greater losses under the Delayed Transition Scenario. Mortgage lending results varied widely by bank, ranging from no climate-related losses to lending loss rates up to approximately three times higher than historic averages by 2050.

Climate-related risks were found to be concentrated in specific regions or industries, including significantly higher mortgage losses in regions, such as parts of Northern Australia, more exposed to severe and prolonged physical risk, and some sectors more exposed to transition risks, such as mining, manufacturing and transport. In response, the banks indicated that they would adjust their risk appetites in these areas.

Commenting on the results of the assessment, Erwin Jackson, Director of Policy at the Investor Group on Climate Change (IGCC), said:

“The assessments show banks changing their lending practices; that means pulling back from banking vulnerable industries and regions. Investors are also undertaking similar approaches in response to climate risks.”

The study also found a need for improvements in data quality and accessibility, with significant variability in the banks’ results caused in part by different modelling approaches and data granularity used by the banks.

Jackson added:

“APRA makes the point well that there’s a lot of variability in the results because the models are new, and the data is incomplete.

“Therefore the government needs to increase funding for the underlying climate science, and the banks need to significantly improve their analysis that translates the science into comprehensive climate risk models.”

Click here to view the Climate Vulnerability Assessment results.