Could the Climate Crisis Lead to A Banking Crisis?

I’ve previously espoused the belief that banks need to be given time to formulate a response to the current climate crisis. After COP26 in Glasgow, it is clear that the costs of wind and solar are falling and production advances in both are happening so quickly, I no longer believe that banks need to be extended the benefit of an extended period to outline their climate practices.

But, this opens up a new reality. A quick transition to an electric economy dependent primarily on wind and solar may result in the rapid abandonment of oil, gas and coal-based generation. We may quickly reach a point where environmental events become so extreme that abandonment of these assets could be required by local or federal authorities. Even without government action, these assets might well be rendered obsolete due to costs of operation, and closed due to adverse public relations of continued operations.

I have many friends in credit departments of the major banks on Wall Street who privately confide that their banks have not performed any sort of sensitivity analysis to reflect the possible implications of default of their fossil fuel creditors or projects. Some of these banks have such extensive loan networks that they cannot even begin to analyze which creditors are fossil fuel creditors and which projects could be jeopardized by the climate crisis or when.

I had believed that while the Federal Reserve has lagged in requiring US banks to analyze this information, we should be able to get some insight and direction from Europe where the European Central Bank (ECB) is several years ahead of the US in analyzing and adjusting to climate exposure. Unfortunately, the news from Europe is not good. The ECB reported this week that of 112 European banks analyzed, not one is fully prepared for the possibility of stranded or abandoned assets. Even today, according to the report, only 28% of the banks surveyed are fully modeling environmental or climate change risks when evaluating a debtor’s credit profile.

At the same time, an article that I found on the ECB report suggests that banks’ credit is much more exposed to a fully functioning ecosystem and cites a French study showing that 42% of security in the French banking system is exposed to the ecosystem.

I think we can boil this down to some very unsettling facts regarding the banking system. First, we are going to get very little information from banks on their exposure to fossil fuels companies; it may take years for the largest banks to begin to quantify their risk internally. Second, the climate crisis poses a systemic risk to the banking system. It is very clear that the entire banking system – and not just the largest banks -- is extremely exposed to the fossil fuels industry and corollary industries (as well as to the nuclear industry), all of which may be forced into obsolescence prior to maturity or even significant loan amortization. Third, banks are equally exposed to disruption and dysfunction in the environment, and they cannot drag their feet in the funding of new solar and wind projects. They should be leading the way on this transition as a failure of the ecosystem would be even more costly for them (and the Earth writ large) than writing off their fossil assets.