Tomorrow Investor

Canadian Banks Need to Rethink Risk Management in the Face of Climate Change


Climate change is rearing its ugly head throughout most – if not all – of the world’s industries, its impact threatening to alter the status quo in numerous devastating ways if businesses refuse to address it. 

The Canadian financial sector is one group that will need to face it head-on, following several findings published in a recent report from the Bank of Canada regarding the impact of climate change on the nation’s banking industry.

Rethink or Fund Up

According to findings gleaned by a risk assessment project initiated by the Bank, Canadian banks and financial companies need to rethink and improve their risk management processes in relation to climate change. Otherwise, they may be required to have capital in reserve against potentially severe losses due to environmental issues.

There were six financial institutions involved, including banks and insurance corporations. Those that participated in the assessment were The Co-operators, Intact Financial, Manulife, the Royal Bank of Canada, Sun Life, and the Toronto Dominion Bank.

The assessment essentially focused on each company’s exposure in Canada and the United States, covering ten of the most emission-heavy sectors of the economy, including agriculture, power generation, and transportation.

The risk assessment project assessed transition risks, specifically those related to policy, regulatory compliance, and legal matters, rather than those physical risks posed by extreme weather conditions such as mammoth blizzards and heatwaves. Data regarding the latter is set to be analyzed at a later date.

Based on the findings, analysts note that the mispricing of transition risks may set banks and similar institutions up for severe and substantial losses, as well as delay any investments made to minimize the impact of environmental issues. The report further stated that any delays in climate policy action are potential threats to the country’s financial stability.

Canada’s financial regulatory bodies declared that they would expect all federally-regulated banks and institutions to build up their capital reserves throughout the current decade in order to weather a potentially volatile transition by 2030.

Four Scenarios to Consider

For this particular assessment, Canada’s financial regulators presented four key scenarios ranging from a baseline of climate change risk policies authored in 2019 to possible outcomes involving immediate and delayed policy action, the restriction of emissions to 2°C under pre-industrial levels, and a stricter restriction of up to under 1.5°C. 

All four of these scenarios are seen as somewhat conservative in light of any potential developments regarding the adoption and implementation of green technologies throughout the financial sector.

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