Banks at bigger risk from climate than subprime mortgages, researcher says

Climate change is posing a bigger risk to bank balance sheets than the subprime mortgage crisis that contributed to the Great Recession, according to the co-author of a new study on the vulnerability of commercial loans.

The study, conducted by the sustainability nonprofit Ceres and released last week, found that up to 10 percent of the value of U.S. commercial loans at leading banks is at risk of being wiped out by the effects of floods, fires, extreme heat and hurricanes.

“There is more risk on bank balance sheets because of climate than there was from subprime housing,” study co-author Steven Rothstein said in an interview with The Hill. “And it took us eight to 10 years to get out of that recession.”

But there is still time — and there are plenty of tools — for banks to adapt and “meet the moment,” Rothstein added.

“The banks have enormous financial risk because of climate change — and enormous financial opportunity,” Rothstein said. The opportunity, he said, comes from the rapid growth of new business sectors such as electric vehicles and green power generation, which offer “more lending and underwriting opportunities.”

The past few weeks have illustrated the rising cost of hurricane-related damage on the Gulf Coast and Eastern Seaboard as well as California’s Dixie Fire.

“Last week alone, we had floods and hurricanes on the East Coast that cost tens of billions of dollars and over 70 lives,” Rothstein said.

Such risks could put $250 billion a year at risk for some of the largest banks, according to the report — and pose an existential threat to many smaller and community banks since they tend to be more concentrated in a specific geographic area and therefore disproportionately exposed to the local devastation posed by wildfire, hurricanes and floods.

In a scenario in which the world does not adapt — what Ceres refers to as a “hot-house” scenario in its study — the value at risk is around 3 percent per year of all assets the group surveyed. That could translate to risks to a bigger share of the economy than the subprime mortgages that led to the 2008 financial crisis.

And unlike subprime mortgages, there is no easy way for banks to divest themselves of assets at risk, Rothstein said, because climate risk is spread so widely through the economy.

The risk is particularly grave for small banks, which “loan in their cities and communities, within a 10- to 15-mile radius,” Rothstein said. “So if, God forbid, a fire affects their community, it affects everyone.”

Climate, Rothstein argued, has become “not just a societal responsibility but a fiduciary responsibility.” That means it’s not simply “nice to think about” anymore, but it impinges directly on the legal responsibility that banks have to protect the material interests of their clients.

“You can’t look at the stability of banks or insurance companies without considering climate,” Rothstein said. “It’s not the only thing, but to consider it, you have to have good information. And we as a society do not have good information.”

There are steps that banks can start taking now, Rothstein said, to address the risk on their books, such as incorporating the same risk forecasting models into their loan approvals that insurance companies have developed, he said.

“We appreciate the work they’re doing,” Rothstein said. “But they need to do more. As President Biden said, this is a red alert situation.”

It’s also important, he said, for the entire banking sector to move together. If just one bank requires customers to come up with a plan to decarbonize, “they go to another plant.”

But “if all of them do it … well, there are 300 coal plants that have closed because they can’t get financing,” he added. “We need to make it expensive so if you’re looking at fossil fuel commitment in coal or heavy industry … that’s built into the price.”