Banks instructed on managing exposure to climate-related financial risks

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The supervisor of banks at the Bank of Israel on Monday issued a set of operating principles for banks to manage their exposure to climate-related financial risks.

Yair Avidan noted the rise in awareness in Israel and overseas about the potential for climate change to negatively affect everything from credit, markets and liquidity to operations and reputations, and, in extreme cases, the banking corporations themselves, entire financial systems and the greater economy.

His paper is based on principles issued a year ago by the Basel Committee, an international body that develops standards for banking regulations.

The Israeli directive, which will come into force in two years in order to give banks time to prepare, lists 12 principles related to corporate governance, internal control, capital adequacy and liquidity, risk management, monitoring and reporting, integration into traditional risk management, and scenario analysis.

Israel’s banks are already required to disclose the environmental risks to which they are exposed and to report to the public on how they are managing them.

Prof Karnit Flug. (Courtesy, Israel Democracy Institute)

In early 2020, a Green Finance Regulators Forum was established under the chairmanship of former Bank of Israel governor Karnit Flug, with voluntary representation from financial regulators, the Bank of Israel, the Finance Ministry’s accountant general, the National Economic Council within the Prime Minister’s Office, the Environmental Protection and Justice ministries, and the Israel Democracy Institute’s Daphna Aviram-Nitzan and Erez Sommer.

The forum meets every two to three months to exchange information and learn about developments in the world tied to finance and the environment.

The finance and business sectors are seen as key to putting the world on course for a greener future because they either fund or are responsible for the bulk of activities that emit global warming gases — from oil rigs and power stations to farms and manufacturing facilities.

Around three-quarters of human-generated global warming gases come from burning fossil fuels, for energy in buildings, transportation, and industry. All the companies involved need investment to operate their businesses.

Yair Avidan takes up his post as Supervisor of Banks at the Bank of Israel on May 17, 2020 (Courtesy)

Those in a position to provide the cash — loans (via bonds) or investments (via stocks) are mainly banks (state and private), asset managers, and big institutional investors, such as mutual funds, pensions, and insurance companies.

At some point in the not-too-distant future, oil and gas producers and companies that depend on fossil fuels are expected to lose value in a move that could hit unprepared investors hard.

This might happen, for example, when renewable energy storage becomes more available to enable a reliable supply of energy and the demand for fossil fuel plummets.

Stocks in an oil company could suddenly lose value if, for example, government legislation forces companies to pay for their own emissions.

Investment in the construction of an industrial plant on the seafront might be exposed to the physical risk of sea level rise.

Avidan said, “The urgency of dealing with climate risks has increased given climatic phenomena occurring in the world and scientific data illustrating the scope of climate risk.”

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