MAS' environmental risk initiative a positive for banks: Fitch

Sustainable financing amounted to around 2-3% of the big three's 2019 loan portfolios.

The inclusion of climate change and other environmental issues in Singapore banks’ risk management frameworks is a positive for the sector as this will help mitigate financial and reputation risks arising from environment-related issues, reports Fitch Ratings.

The Monetary Authority of Singapore (MAS) recently published a consultation paper that looks to formally guide banks to embed environment risk assessment in their risk management policies.

The proposed guidelines put the onus on banks' boards and senior management to identify, assess, and monitor environmental risks on a customer and portfolio basis and to provide regular disclosure of such risks to their stakeholders. Banks are expected to implement these guidelines within 12 months upon the release of the final rules.

According to Fitch, environmental risks affect banks' balance sheets—not only through direct physical risks such as damage to financial assets or collateral values due to extreme weather events—but also from transition risks as the world moves towards a more environmentally friendly economy.

“For example, there may be exposure to obsolete business sectors or stranded energy assets, as industries transition to a low-carbon economy,” the report added.

Currently, the big three banks—DBS, OCBC, and UOB—have already integrated environmental risk considerations into their risk frameworks. In 2019, the three banks also announced that they would stop financing new coal-fired power plants.

The banks have identified growth opportunities in supporting the transition to a low-carbon economy. Sustainable financing amounted to around 2%-3% of their total loan portfolios as at end-2019. This is expected to grow in the coming years, with OCBC targeting a sustainable finance portfolio of $25b by 2025, after surpassing their $10b target in March. This is equivalent to around 4% of their total loans.

DBS, OCBC and UOB are also three of just four banks in ASEAN to have pledged support for the Financial Stability Board's Task Force on Climate-Related Financial Disclosures (TCFD), which is a market-driven initiative to encourage corporate disclosure of environmental risk.

ESG as a prudential requirement
Fitch believes that environmental risk awareness may no longer be a corporate social responsibility initiative, but a prudential requirement.

“Banks' adoption of strategies to mitigate climate-change risks is not merely a public display of commitment to the environment. It increasingly makes financial sense for them to do so, as materialisation of these risks may have negative consequences for their asset quality and profitability,” the report noted.

“However, as momentum for banks to exit certain relationships or reject certain collateral gathers pace, credit implications could be magnified—a crowded fire exit can be a dangerous place during an exodus. Banks that act ahead of these challenges would be better-positioned against environmental risks affecting their credit profiles.”

Globally, more banks are expected to pay more attention to climate risk management, with new regulatory requirements centered on environment and climate-related issues helping to accelerate this process.

As of 2019, only around 40% of global banks have incorporate climate-risk considerations in their risk frameworks, an earlier survey by Fitch on environmental, social, and governance (ESG) criteria revealed. According to the survey, company policies and regulation were the most important drivers for increased awareness in climate risk management.