A concerning report from a climate change nonprofit highlights the potential destructive losses facing America’s smallest banks due to climate-related weather disasters. The report reveals that these banks are facing significant risk, with property damage threatening a collective $2.4 billion across almost 200 national banks. This amounts to an average of 1.5% of these banks’ total portfolio value, mainly impacting small regional or community banks. Even larger institutions are not immune, as one in four of them also face climate-related risks.
The analysis conducted by First Street focuses on extreme weather risks in banks’ physical locations as a proxy for the properties on which these banks have issued loans. Nearly one-third of the nation’s banks are exposed to climate-related risks that could decrease the value of their holdings by at least 1%, a significant threshold set by the Securities and Exchange Commission that requires reporting.
While some regulations exempt small banks from certain financial reporting requirements, experts warn that many of these institutions may not fully understand the level of risk present in their portfolios. As the costs of weather-related disasters continue to rise due to climate change, it is crucial for banks to comprehend and address these risks effectively.
Challenges in Assessing Climate Risk
Evaluating climate risk poses challenges for banks of all sizes, with smaller institutions struggling to establish and price this risk effectively. Current methodologies for estimating potential bank losses based on branch locations may yield varied figures, making it challenging to accurately assess the extent of the risk. Experts emphasize the importance of conducting a detailed loan-level analysis of portfolios by utilizing climate models to evaluate physical risk based on address data.
Despite the complexities involved in analyzing climate risk, the need for proactive risk management frameworks that incorporate climate risk is evident. The Federal Reserve and other regulatory bodies are recognizing the importance of addressing climate risk through stress tests, paving the way for mandatory reporting practices in the future.
