Skip to content
Insights on topics affecting
Canada’s banking sector

Managing the financial risk of climate change

Feb 10, 2022 • 6 min

Darren Hannah

By Darren Hannah

Vice-President, Finance, Risk & Prudential Policy
Canadian Bankers Association

Climate change is one of the most pressing issues of our time. Driven by a collective purpose to help their customers thrive and communities prosper, banks in Canada are taking action to address climate risks, help build a more sustainable future and strengthen our country’s response to this inter‑generational challenge.

Financial institutions around the world have traditionally viewed climate change through the lens of their Corporate Social Responsibility efforts. That perspective, however, is changing because of a growing recognition of the immediate financial implications and potential future risks related to climate change. Canada’s banks are now incorporating climate considerations into the very core of their financial risk management frameworks.

Climate change has a financial dimension and therefore is an emerging type of risk. For that reason, banks are evolving their thinking around risk management to factor in new dimensions and taking concrete steps to address them. By being laser‑focused on incorporating climate considerations and staying resilient, banks are helping underpin Canada’s gradual transition to a low‑carbon economy.

Establishing a baseline measure of climate risk

Canada’s Superintendent of Financial Institutions, Peter Routledge, recently remarked that climate risk is a "right now" challenge. The banking sector recognizes that immediate action is necessary to confront climate risks and that progress on this front should not be punted to a later decade.

As I’ve expressed in a previous entry on CBA Briefings, an essential first step is to increase shared understanding of the challenge through better data on climate risks. Financial system participants need more information to appropriately assess, price and manage physical and transition risks and, by extension, support the smooth transition to a net‑zero economy by 2050.

The Canadian banking sector supports climate‑related financial disclosures through a harmonized set of guidelines for climate change reporting that reduces the potential for global fragmentation. Every large Canadian bank is already working on implementing disclosures developed by the Task Force on Climate‑Related Financial Disclosures (TCFD). Considered a global standard, TCFD sets a clear path forward for measuring climate risk, supports comparability across financial institutions, and provides consistent guidance and information for various stakeholders.

Disclosure only matters if everyone understands it — that’s why global alignment on TCFD is a significant step forward. Data shared through climate disclosures, using a widely agreed‑upon framework, will help build a common understanding of the challenge we face and how best to organize our collective response.

Evolving risk management capabilities

Canada’s banks are prudent, forward‑looking institutions that guard against a widening range of potential outcomes in financial markets and the real economy. Every day, banks carefully assess risk when making lending decisions and as they ensure the continued resilience of their businesses. In the same vein, banks are now beginning to bolster their capacity to measure and manage the physical and transition risks posed by climate change to their business and loan portfolios.

While banks are in the early stages of enhancing risk assessment capabilities to include climate‑related factors, including the use of climate scenario analysis to assess exposure, they have a successful, decades‑long track record to leverage. The management of climate risk is a new exercise that will become more mature over time. We look forward to continuing to work with the Office of the Superintendent of Financial Institutions (OSFI) on this front and await its draft guideline on climate risk management for consultation to be released later this year.

The banking sector is only one piece of the puzzle. We support, and indeed encourage, all businesses in Canada to undertake climate change mitigation actions to help guide their own strategies, business models and decision making, and therefore help our country make the shift to a greener economy over time.

Sufficient capital buffers

Banks in Canada already have adequate capital cushions to allay unforeseen shocks to their balance sheets. OSFI’s capital framework is designed to capture climate‑related financial risks as part of the overall approach to managing credit, market and operational risks. From a banking perspective, climate is not a standalone financial risk but rather a growing factor that shapes and influences the risks that banks are already managing.

standout quote that says From a banking perspective, climate is not a standalone financial risk but rather a growing factor that shapes and influences the risks that banks are already managingMany banks maintain operational cushions well above OSFI’s minimum capital requirements of 10.5 per cent. Taken together, banks in Canada have set their Tier 1 capital ratios at an average of 14.88 per cent to guard against a full range of events that could compromise their balance sheets. The Canadian financial system has demonstrated resilience to several external shocks, including the Great Recession of 2008‑09 and the coronavirus pandemic, thanks in part to a well‑capitalized banking sector with a strong focus on risk management.

If OSFI were to introduce an additional capital buffer specifically for climate risk, international harmonization would be crucial. To be sure, there would be a substantial impact to raising capital requirements in Canada if regulators in other countries did not follow suit. Maintaining competitive policies, capital and tax structures in this country would be essential to maintaining a prosperous Canada and financial well‑being for Canadians.

A continuum of effort

The response to climate change will be a complex, multi‑year undertaking. While our work on this front has already begun, climate factors have a longer‑term operational risk horizon. Banks will therefore use an iterative process to manage this emerging type of risk.

Addressing climate risks is an evolution. Only three short months ago did banks, insurers and asset managers sign onto global efforts to tally up financed emissions and integrate environmental aspects into investments and lending, efforts that intensified with the COP26 summit in Glasgow, Scotland, in November 2021. And a concerted effort is still underway to articulate a clear strategy in Canada for how we’re going to make the transition to net‑zero emissions by 2050.

What is clear, however, is that Canada’s banks are taking the fight against climate change seriously and are adapting their risk management capabilities to treat climate risk as a financial risk. This is a sea‑change in perspective that will set the sector down a bold new path to a more sustainable future.