The transition to a low-carbon economy poses a fundamental challenge to the world’s financial institutions, warns Moody’s Investors Service.
The rating agency, which is launching a six-week campaign to highlight the risks and opportunities facing the financial sector from the push by global policymakers to decarbonize their economies, said firms that don’t embrace the shift face a growing threat to their businesses.
“A timely and comprehensive pivot toward a low-carbon economy will lead to a transformation of business models,” Moody’s said in a report, with banks and insurers likely to be more affected than asset managers.
“Firms that fail to transform will face an increasing threat to their competitive positions,” the report warned.
Banks will face risks to their franchises and their credit profiles from their exposures to climate-intensive industries, Moody’s said, “while climate-focused regulations and stakeholder pressures will intensify legal and reputational risks.”
“Together with increasing regulatory scrutiny, decarbonization will fundamentally alter decisions regarding the cost and benefit of lending to, and investing in, carbon-intensive sectors. Banks will need to ramp up their climate risk assessment capabilities, as well as governance and risk management frameworks,” it said.
These pressures come as the banking industry is already facing other fundamentally disruptive trends, including the increased digitalization of the industry and rising cyber risk, Moody’s noted.
The addition of the “unprecedented challenge” of decarbonizing “risks compounding many of the industry’s other transformative forces,” the report said.
In the insurance sector, firms are already feeling the effects of climate change through an increase in extreme weather events that is “driving up physical risks in their underwriting portfolios, which will lead to more profit volatility and potentially lost premium revenue as some risks become uninsurable,” the report said.
Additionally, the risk of stranded assets in investment portfolios will rise with a low-carbon transition, as does the prospect of higher claims stemming from climate-related litigation against corporate clients.
“Insurers face increasing scrutiny of their carbon footprint from investors, regulators, clients and the public, which will require them to take decisive action. Those able to shift their business models and innovate faster than their peers will avoid the worst effects of climate change and benefit from new business opportunities,” Moody’s said.
While the threat isn’t as severe as the one facing banks and insurers, the asset management industry’s exposure to carbon-intensive industries is “also substantial,” Moody’s said, “and climate change is severely testing their ability to navigate investment risk.”
“Firms that preemptively identify and manage climate risk in their investment process can protect themselves against losses. Furthermore, asset managers can considerably benefit from opportunities in developing investment solutions that contribute to a low-carbon economy, meeting investors’ sustainability expectations,” it said.
The transition to a low-carbon economy also promises new financing opportunities for banks, as the shift will need vast investment in the form of lending and capital market funding, Moody’s noted.