By Meg Sczyrba, CRCM
Natural disasters have become more commonplace, because of climate change. While events such as floods, wildfires, droughts and ocean acidification might feel far taken off our world of bank compliance, their impact is already forcing subtle shifts within our daily work. As global warming intensifies, its impact on our jobs will continue to grow.
Climate change hasn't gone unnoticed. President Biden recently signed the Climate-Related Financial Risk Executive Order. It encourages bank regulators to evaluate climate risk and asks Treasury Secretary Janet Yellen to issue a report quickly how bank supervision will incorporate climate-related financial risk. Yellen had previously called global warming the largest emerging threat towards the health of the U.S. financial system
The Basel Committee on Banking Supervision has additionally considered climate risk and published several white papers on the subject at bis.org. This international group of regulators quantify the risk for the financial services industry as twofold:
- Physical risk. The chance of financial loss caused by the increasing severity and frequency of utmost climate change-related weather events for example heatwaves, landslides, floods, wildfires and storms in addition to indirect results of global warming.
- Transition risk. The risk related to the entire process of adjustment towards a low-carbon economy, including funding commercial loans.
Regulators have primarily concentrated on credit risk but will undoubtedly turn more attention to regulatory risk. To organize compliance officers for your eventuality, this article considers how the physical perils of climate change are impacting the guidelines we work with daily.
Climate change basics
Climate change is a very large issue, but compliance officers are skilled at issue management. After learning of the concern, the initial step would be to perform a real cause analysis, or perhaps in this case, to know climate change basics.
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According towards the National Aeronautics and Space Administration, burning non-renewable fuels like coal and oil releases co2 in to the atmosphere. This transformation traps more heat which in turn causes the Earth's average surface temperature to rise. In additional concrete terms, the United Nation's World Meteorological Organization found the Earth's average surface temperature is now consistently one degree Celsius warmer of computer was in 1900. While one degree may not sound like much, every amount of change includes a considerable effect on long-term weather patterns. And, the temperatures are rapidly approaching the fir.5 degrees Celsius (2.7 degrees) benchmark where climate change creates significantly more problems and potentially becomes irreversible. The agency warns there is a 44 percent chance the Earth will reach this pivotal point over the following five years. (Because of the additional carbon in the atmosphere this year, the agency's projection is double last year's projection of 22 percent).
Climate change impacts include rising sea levels, extreme storms, prolonged high temperatures and droughts. These events can modify the physical environment to pave the way for more pandemics. Additionally, the carbon dioxide resulting in the increase in temperatures is also turning oceans more acidic, which can affect the entire food web. While all these events are occurring globally, geographic regions is going to be impacted differently. NASA explains that some U.S. regions have seen increased rainfall while others have experienced decreased precipitation. Those trends are required to carry on, with future climate changes coming faster than in the past. Climate change predictions will also be determined by amounts of future emissions of co2.
Rising sea level and extreme storms
As the planet gets hotter, increased surface temperatures impact the ocean in two basic ways: water expands because it warms, and ice sheets and glaciers melt faster. Both bring about the rising sea levels. Morgan McFall-Johnson, a science editor at Business Insider, estimates that the sea will rise three and a half to seven inches by 2030-twice as quickly as the prior 20 years. Additionally, the nation's Oceanic and Atmospheric Administration cautions the rising sea level boosts the risk of high tides and puts coastal communities at great risk for erosion and storm surges. This transformation would impact 53 percent from the U.S. population based on a study conducted by Arenas Lam, et al., in 2009.
Because the warmer atmosphere can hold more moisture, storms will bring heavier and much more frequent rainfall. Based on the 2022 BCBS white paper \”Climate-Related Risk Drivers as well as their Transmission Channels,\” storms may cause flash flooding and landslides that will damage property and infrastructure. Across the coast, the additional warmth and water means hurricanes is going to be slower, stronger and grow faster and intensely. McFall-Johnsen also estimates that by the close of the decade, the Northeast coast are experiencing a fivefold rise in annual floods
The BCBS addressed the expected financial impacts of these extreme storms. Besides the immediate harm to homes, the worldwide group of regulators predict insurance costs will double in the near-term future. Increased costs could render insurance unaffordable to some homeowners or, if the costs to insurers are extremely high, it could potentially be unavailable in certain areas. This includes flood insurance, the subject of regular debate and frequent short-term extensions inside the U.S. Congress.
Renee Cho, author and researcher for Columbia University's State from the Planet, relays that insurance rates had already increased 50 percent between 2005 to 2022. In her December 2022 article, she also predicts that local taxes will rise as communities take actions to prevent future flooding. These actions could include for instance, creating a comprehensive grid of levees and dams.
Heat waves and droughts
Extreme storms aren't the only real global warming impact. NASA predicts summer temperatures could keep rising, specially in the western and central Usa. These long periods of increased heat is going to be especially impactful to agriculture. NASA also predicts that extreme weather will lead to crop losses despite an increased growing season. BCBS reinforced concerns about the financial impacts to farming. Along with limiting agriculture output, warmer temperatures dry out plants and trees, which in turn ignite more easily and can lead to more frequent and larger wildfires. McFall-Johnsen estimated that forests are burning at twice the speed they did in 1984. Conditions in California are much more severe-the annual area burned in summer wildfires increased fivefold between 1972 and 2022. In dollar figures, the 2022 wildfire season around the west coast cost insurers between $7 to $13 billion.
Warmer temperatures could also impact jobs. Cho predicts the sequential prolonged high temperatures will make working outdoors so unbearable that laborers may shift away from outdoor work like agriculture and construction. This transformation will disproportionately impact people in minority groups, particularly the Hispanic or Latino community, based on Department of Labor and Bureau of Labor Statistics reports. This is especially true in agriculture where 83 percent of farmworkers identified as Hispanic.
Higher temperatures also lead individuals to use more energy for cooling their areas. Cho noted that 93 percent of U.S. cities have previously seen increased days requiring extra cooling. She predicts utilities will raise electric rates as the probability of blackouts will even increase. In addition, local taxes may also rise as municipalities seek to repair harm to infrastructure caused by the higher temperatures. For example, roads will have to be repaved more frequently.
Ocean acidification and pandemics
According to NOAA, the ocean absorbs about 30 percent from the carbon dioxide in the environment (). As the levels rise in the atmosphere, seawater also assumes higher amounts, triggering a chemical reaction that results in more acidic oceans. McFall-Johnsen predicts the resulting mass migration of marine life will directly impact those who earn a living on the seas.
On land, global warming reshapes the environment, driving species to migrate to new, more desirable habitats. This includes animals, plants as well as viruses and bacteria. These shifts could place them in closer proximity to humans, which was one underlying cause of the COVID-19 pandemic. Robert Preidt, of WebMD explains that warming temperatures modified china terrain to become more hospitable to bats, that are recognized to carry coronaviruses. In fact, Preidt states, \”an additional 40 bat species that harbor 100 more types of bat-borne coronavirus have moved into Yunnan province [where COVID-19 originated]in the past century, according to the study published Feb. 5 in the journalScience of the Total Environment.\”
Compliance implications of climate change
After adopting the real cause, compliance officers need to consider compliance implications of the issue they are investigating, by applying their knowledge of the regulatory environment. When it comes to global warming, the resulting rising sea levels, extreme storms, heat waves, droughts and pandemics will each impact compliance. Consider the following:
Appraisals. Real estate appraisal regulations require banks to obtain a formal property valuation prior to securing a real estate loan. BCBS notes that severe weather events cause property values to decline so banks may wish to ensure their appraisers adequately factor climate vulnerability to their valuation. While there is evidence that immediate impacts may be factored into the price of the real estate by savvy buyers, future impacts could be more hard to discern. For safety and soundness reasons, though, banks will need appraisers to take into account long term impacts due to the length of time mortgages remain on the books. Banks will need to ensure any global warming valuation considerations are addressed uniformly.
Community Reinvestment Act. CRA requires banks to report their consumer and business lending annually. Regulators then evaluate the bank based on its lending to low- and moderate-income areas in every category. Global warming presents both impacts and opportunities in this region of compliance.
The Federal Reserve Bank of San Francisco's \”Climate Adaptation Investment and also the Community Reinvestment Act\” white paper acknowledges that low-to-moderate-income communities are highly vulnerable to climate change impacts simply because they have fewer resources available to weather the storms. The regulator noted that a high number of counties impacted by past climate change-related disasters had CRA-eligible tracts. Banks may want to possess a plan in position for how to continue meeting LMI lending goals as global warming impacts accelerate.
Taking it one step further, the white paper procedes to encourage banks to support community investments to reduce climate change vulnerabilities. Regulators will positively consider all activities that either prevent disaster or revitalize a disaster area, particularly in LMI neighborhoods.
Another CRA opportunity arises as laborers choose to steer clear of the heat, shifting from outdoor jobs. Banks supports economic development through workforce training programs in communities feeling the economic impacts of climate change. Because smaller farming operations are not as likely to be able to absorb the additional expenses global warming will bring, banks may find it increasingly hard to make prime loans in this sector. Unless the rule is amended, banks may have to choose between CRA ratings and losing money on more questionable loans.
Fair lending. There are many ways that climate change will have to be addressed within fair lending compliance:
- Biden's executive order expresses concern for climate change's disparate impact on minority communities. There are several underlying causes for increased vulnerability. Like LMI communities, this population tends to have less savings available for added expenses. The predicted job shift away from outdoor work could exacerbate this situation.
- In addition, BCBS discovered that banks are inclined to reduce lending to climate exposed areas. As banks modify underwriting practices to account for climate change, they'll be thinking about the outcome on minority lending. And if banks place underwriting restrictions on affected geographic areas, banks may wish to consult mapping that identifies minority census tracts. If there is significant crossover, banks may wish to document their business justification for their actions.
- BCBS notes that climate change have a negative impact on the ability of some borrowers to repay. Homes may need expensive repairs while rising insurance, taxes and bills add up to make homeownership more expensive. To avoid allegations of predatory lending, banks will have to ensure they aren't putting borrowers right into a loan they cannot afford either in rapid or long-term. Additionally, banks will have to find a way to uniformly underwrite home loans to take into account these added expenses.
Flood insurance. Rich in water events increasing, mortgages may wind up underwater-both literally and figuratively. Flood insurance rules can protect both banks and homeowners-and both will need the help. To guard all interests, banks should pay particular attention to the following aspects of the regulation:
- Banks must verify whether a borrower's community is participating in the National Flood Insurance Program at that time financing is made, modified, or renewed. It will likely be important to stay up-to-date on community status, as this could change rapidly depending on how quickly communities react to the elevated risk.
- Special Flood Hazard Area maps may also evolve quickly. The Federal Reserve Board of Bay area Bank published a Community Development Innovation Review centered on Ways of Address Global warming Risk in Low- and Moderate-Income Communities (2022). The Review finds our current mapping is out-of-date and does not adequately capture flood risk. Global warming will exacerbate this mapping inadequacy. At least, banks will want to ensure their flood vendor maintains up-to-date software. They may also consider exploring new methods to better evaluate flood risk.
- Banks need to ensure that flood insurance is maintained throughout the life of the borrowed funds. With flood insurance costs expected to continue rising to the point of being unaffordable, banks may wish to determine in advance, how to deal with borrowers who can no more afford required flood insurance.
RESPA. Compliance officers are too aware of the stress the pandemic put on compliance and therefore are likely still dealing with a few of the fallout. Probably the most critical implication was to RESPA, which regulates how banks use customers in arrears. If the added expenses of home repairs, insurance, taxes and utilities are significant, there might be a brand new improvement in existing homeowners going into mortgage loan modification or foreclosure. (For more information, see \”The Long Shadow: COVID-19 Is constantly on the Pose Significant Compliance Challenges for Mortgage Servicers.\”)
Risk-assessing climate change
Once compliance officers have determined the entire extent of an issue, they think about the degree of risk involved. In this instance, they'll want to consider the impacts climate change may have on existing risk assessments in whatever manner that's done inside their bank. If regulations are assessed separately, then each of the above rules should be thought about for increased inherent risk using the risk trend increasing. Other areas of the bank such as operational risk and credit risk may also want to acknowledge these shifts while the bank itself may want to conduct a stand-alone climate risk assessment.
Overall, climate change is clearly risky business. We're already experiencing its impacts in the form of rising sea levels, extreme storms, prolonged high temperatures, droughts, ocean acidification and pandemics. The impacts to our physical environment and consequently the financial system by which we work are predicted to worsen rapidly. While we can collectively work towards curbing underlying causes, understanding climate change and the risks it poses prepares us as compliance officers to help our banks navigate this emerging and unprecedented risk.
Meg Sczyrba, CRCM, has been active in the compliance industry for over 25 years and currently chairs the editorial advisory board of ABA Bank Compliance magazine. She formerly chaired the ABA Compliance School and CRCM advisory boards and participated as a person in the ABA Compliance Executive Committee.
