Week 5 Flashcards
Why are banks important to consider?
in countries where banks dominate the financial system the energy transition will have to be funded by banks
eg. Japan or mainland Europe
- capital markets are not the only means of transitioning
- there is cross country variation so need to think about how capital markets and banks interact
not every large company is publically listed - banks are a means of reaching smaller private sectors and their emissions level and further information
Is there pressure on banks to decarbonise?
increasing pressure
- central banks actions affect banks - quantitative easing, capital requirements - including pressure to disclose information on banks climate exposures
eg.BOE and ECB requirement for climate stress tests due to physical and transition risks - discussion of the Basel Framework - usually around banks capital requirements, but recent discussions are now centered around a climate change related Basel framework
- gradual expansion of bank involvement via bank commitments - net zero banking alliance 04/2021
Is there any evidence of banks acc decarbonising?
- 60 major banks have allocated $4.6trillion into ff industry since 2016 - $742bn in oil-gas-coal in 2021
lending is sticky - transition risks are not fully clear - large firm-level heterogeneity in emissions within industries
Is there any evidence of banks decarbonising their portfolio in relation to physical risk?
- banks tend to adjust their mortgage terms in response to changes in physical risks
they are in essence internalising the physical risk through the adjustment of the contracts. legislation risks - facing stronger legislation risk, banks increases costs of commercial loans to the ff industry
Is there any evidence that banks are decarbnoising their portfolios in relation to transition risks?
banks tighten credit following Paris agreement and loosen credit following trump election
banks have to align with stricter regulation - they have to be stricter on brown sectors
Does bank decarbonisation trigger real adjustments in the companies that they lend to?
- effect on corporate real and finanical decisions - GHG emissions
- green firms benefits more from green banks
Why do banks commit to net neutrality?
= shareholder pressure
- institutional ownership, loyalty by clients and board size
decision to commit is not random - cost and benefit of choice is considered
but pressures might be heterogenous in geography and size of pressure
What are some particular characteristics of bank’s commitments to net neutrality?
- all commitments cover scope 1 direct emissions
- most commitments involve absolute and intensity of emissions
- no specific targets in data but more and more being set
- uncertain as to the impact of these commitments as it is early days
What condition (of two) does a firm have to be considered exposed to a committed bank?
- if at least one of its previous lenders commits to SBTi
- condition commitments no the subset of lead arrangers
-intensive margin = % of committed banks and lead arrangers
Why do we look at the syndicated loan market?
companies or banks lend capital to a firm either through a lending facility bilaterally or through the coalition of banks pulling money from multiple sources
- difficult to get the granularity of information of all the companies that are borrowing money from banks and the lending portfolios
- in a syndicated loan if only one bank has made a commitment then the borrower is exposed to a commitment
What is a lead arranger?
in a syndicated loan system there is a leader that in a sense organising the gathering of sources of capital for the syndicated loan
When was the SBTI established?
2015
How many US banks made SBTi commitments in the 5yrs post SBTi establishment?
0
the pressure is greater in europe therefore European banks are more likely to make commitments
How did the paris agreement impact the commitments by banks to the SBTi?
3 waves of commitments - staggered commitments
1st wave around the pairs agreement eg. West Pac
then again in 2016 - eg. HSBC
then again in 2018 eg. Standard charted
How has company exposure to commited banks changed over time?
2015 around 20% of firms were exposed to committed banks
increased around 2016 to 60%
small number (22 banks) of banks take up a large amount of the syndicated loan market (thousands of companies)- some banks committing does a lot for firm exposure
this is not a small localised shock it effects a lot of countries
last wave - fraction doesn’t change - overlap of exposure, already exposed by banks that have already committed
stay at 60% of companies exposed to committing banks
Is there a geographical distribution of firms that are exposed to committed banks?
no it is a global phenomena
of ~2100 companies 60% were exposed to committed banks
consistent with the idea of global banks
Why is the US interesting?
No US banks are committed but US make the largest percentage of companies in the sample and are the largest exposed to commitments
What is the effect of high emissions and an exposure to a bank committing
Comapnies exposed to a commiting firm prior to them committing - once the bank commits there is a reduction in the amount of debt that is given to the high emissions firms relative to the low emissions firms
not just from the committed banks but from all banks
there is a 6 percentage point reduction in total debt available to these firms for bank sourced financing
there is no full substitution in terms of other sources of financing
nb this is looking at syndicated loans
Do banks also respond to changes in scope 2 and 3 - why or why not?
Companies with higher scope 2 and 3 emissions do not suffer in the same way that high scope 1 firms suffer
this is consistent with banks commitments to SBTi and to focus on the commitment to scope 1 emissions
not necessarily a bad thing - scope 1 of 1 company could be a scope 3 of another company
nb this is looking at syndicated loans
Is the non-banking sector taking up the slack in potential business from banks restricting their lending?
nope
there is no compensation in credit coming from the non-banking sector
the effect is a drop by 12 percentage points
What is the total effect across banks and non-banks on high emissions companies?
12 percentage point reduction in capital available to the firms
Can you explain the differences in extensive and intensive margins in the context of bank lending?
Intensive is how much each of the lenders actually lend to the firms in a loan - what is the intensity of the relationship are lenders renewing their contracts
Extensive is how much lending a firm is doing with that firm, ie. are they giving out new loans
What impact has bank commitment had on intensive and extensive margins
in terms of syndicate loans
the biggest impact has been on the extensive relationship i.e ho much banks are lending new loans ot high emitters
much harder for banks to change existing loans, much easier for them to just not issue new loans to high emitters
high emitters are much more likely to just re-finance an existing loan
What kind of banks make commitments?
multinational banks
small number but their impact is big due to the large fraction of companies that are exposed to them
What is the demand side story for the reduction in banks giving debt to brown industry?
could be that brown industries and companies don’t have as high capital requirements because they don’t require the capital requirements to expand
- it will become an old industry and therefore less requirement for capital investment as there is less cap going on in the future
What is the supply side story for banks not lending to brown industry?
the company has demand for debt but the banks don’t want to lend
How could you use Chevron as an example of how to eek out whether the supply or demand side story dominates?
Chevron is a brown company with a large carbon footprint for scope 1 and 3
access to 2x banks eg. HSBC with a commitment and BoA without commitments
if it was a demand story - chevron no longer needs capital it wouldn’t matter if the cap came from HSBC or BoA
if supply story - there would be differential amount of how much debt is obtained from HSBC and BoA
So in summary what are the three ways you can use loans to look at the impact of committed banks?
- Extensive margin analysis - how much lending- ie. are there commitments for future loans
- Intenstive - how much of each loan - the actually quantity of the lend to a firm - scaling the quantity of the loan
- Firm yr quarter - comparison of committed banks with non-committed banks lending to the same firm in the same quarter depending on firm carbon emissions
From the loan level results what force is the most pressing?
Extensive
commiting banks are adjusting their behaviour by reducing their new loans to the companies in question
1.5% less likely to give credit is the average effect - relative however, so you would be 1.5% less likely to get an HSBC loan than an BoA loan
What does the loan-level evidence tell us about syndicated markets?
the results suggest that the reduced lending effect is true in the syndicated markets
the effect is primarily coming from fewer orgination of loans (extensive margin) rather than from changing the existing loans (intensive margin)
the effect is largely supply-driven rather than demand-driven since we control for very granular demand shock - firm-level fixed effects
What is a good way of measuring whether the interest on loans changes for brown firm loans?
Can’t observe the price of each loan therefore can look at income statements - companies report an interest expense
Why would it be interesting to look at interest rates?
Banks could respond by increasing the interest for loans to brown rather than green industries
What is the effect of banks commitment on the interest expense?
it is marginal though it is slightly positive and sometimes statistically significant
the result suggests that banks mostly discipline firms through credit rationing rather than repricing
it is more about reducing the quantity of cap exposed rather than the price to the brown industry firms
it is much harder for banks to change the interest on existing loan
Do firms internalise credit shocks in their decisions?
the results suggest that firms respond to the financing shock -a reduction in credit supply ie. bank and total debt is reduced and there is no substitution of equity for debt
results are consistent with a model of financial inflexibility due to external shocks
leverage, investments and assets go down
liquid assets go up - liquidate assets to have some extra capital to invest, there is a 2% drop in value of assets if exposed to committing banks
auxiliary predication that ROA goes up - least profitable projects are cut in companies under fin distress –> cut the lowest margin projects relative to the whole business
Do firms respond to bank pressure by changing their decarbonisation and ESG activity?
Exposed firms do not seem to reduce their emissions within subsequent 3 years, even thought there is pressure applied dby banks this has not led to them decarbonising their business
they also do not change their rate of SBTi commitments or waste management or investment more on environmentally related projects or investing in renewables
The visible difference is an increase in E-score of MSCi rating
- therefore despite not making further commitments, investing in renewables or changing their waste management processes the MSCI would suggest that they are becoming better as a result of the shock
What is actually changing post shock of committed banks to the MSCi score?
S and G are not changing.
- Environmental opportunities = defined as being soft communication - we promise to be a better company in the future - potentially greenwashing - all a bit fluffy
results suggest that the driving force behind an increase in E score is the increase in environmental opportunities category but not in hard factors like climate or carbon
the opp category is a soft cateogy and suggest that firms are mostly representing in a way consistent with greenwashing
What does the return on asset evidence tell you about what firms are doing in response to pressure from committed banks?
The story is that the companies are choosing profitability over carbon footprint
Is there a re-allocation of bank debt to green companies?
Yes the opposite of what is happening with brown companies is happening to green companies - they are receiving greater credit and investing more
What is a rationale for why profitability might be more valued than emissions reductions or ESG?
managers only get rewarded for the short term value of the business - share value - profitability matters for most managers
there is a trade off between profitability and esg considerations = not always aligned
difficult when you have multiple projects not always homogenous therefore reducing emissions is not always a simple fix
Are banks changing their behaviour towards emissions?
- commiting banks do condition their credit decisions on firm emissions
- credit supply mechanisms
- no full substitution with other lenders and nonbank debt stable = total debt and leverage cut
How do firms internalise the pressure of banks?
firms internalise this effect on corporate decisions but less so on their decarbisastion actions
- reduction in bank lending to brown firms lowers firm real investments and assets
- no firm level cut in carbon emissions or increase in future commitments - hard choice or data
- greenwashing - some positive effects on E-score but driven largely by potential expenditures on green activities
- firms tend to cut the least profitable projects to increase an average ROA
- banks affect carbon emissions via credit relationships from brown to green firms rather than via providing loans to brown firms for the investment necessary to cut carbon emissions
What is the role of central banks?
macroprudential policies - focus on the stabilty of the whole system
they are the lender of last resort - when very large banks become insolvent would be a v large systematic risk to the entire company - need someone to buy their assets
What are macro-prudential policies?
need to look at the whole system rather than individual firms
regulate capital, equity
eg. basil regulations - decide on how to regulate banks and how much equity cap is required
What is stress testing?
yearly or bi-annual testing - asking what would happen if the economy crashed and unemployement drops by 10% - macro scenario - what would be your losses and would you have enough capital to absorb that capital
a means of testing the resilience of the system - anticipating what could go wrong
When was the great financial crisis?
2007/9
What were the consequences of the great financial crisis?
central bank introduced new policy tools like stress testing and focused on facilitating resolution to avoid bailouts
How was cliamte changed considered prior to the great financial crisis?
- carbon emissions were moslly seen as an externality that needs to be priced
- carbon taxation, emissions trading schemes
- integrated assessment models and the social cost of carbon
How as cliamte change considered post great financial crisis?
2010 = Robert Litterman outlined:
- the risks and potential disasters associated with insufficient pricing of risk
-issue is that emissions are not reflecting a premium or even expected discounted damages
- not pricing systematic risks leads to too much risk being taken - could lead to a global catastrophe
What was the impact of covid on the financial markets
went into a finaical crisis in march 2020
- capital markets dried up and people were no longer willing to hold bonds they wanted cash
banks have a day by day operation and couldn’t refinance overnight because the finance is no longer available = collapse
How did lenders of last resort intervene in the financial crisis associated with covid?
March
- Fed announced $700bn in US treasury bonds purchases
- ECB announced E750bn of government and corporate debt purchases
fed restricts dividends and stock repurchases
natural disaster can cause financial turmoil
What is the difference between the fed and ECb’s mandate?
the fed has a mandate to control inflation, price stability and economic activity
the ecb only have a price stability mandated
both have expanded their mandates out of necessity - financial stability is a dominant issue
transfer of power from national governments to supra-national authorities
What was the momentum consequences of paris agreement for central banks?
One planet summit in December 2017
April 2018 - first climate risk conference - central banks and supervisors
2018 - NGFS report
2020 - US FED joins the NGFS
What does the NGFS do?
- write reports = 2018 report = climate related risks are a source of financial risk, it is therefore within the mandate of central banks and supervises to ensure the financial system is resilient to those risks
- collaborate on best practice and regulation
- understanding on how climate-related risks could materialise in financial risk
What concept do supervisoers use to measure risk?
value at risk
What is value at risk?
- value at risk is a measure of risk of any asset on the balance sheet of banks
- what assets could face of a loss of a certain size with less than 5% probability
i.e what are the size of the losses and what is the value of the loss - probability of the even is determined using historical events - probability estimate - however this doesn’t take into account the fact that the economy has changed in response to the previous changes
- related to tail risk - fat tails different to normal distribution
if you cant use value at risk as a measure of cc risk then how do you go about doing it?
What are some of the issue with how cc is currently being assessed and who said that?
The Green Swan - Jan 2020
- traditional backward looking risk assessment models are inadequate
- best science today = CC is almost certain to occur but uncertain on timing and realisation
- IAMS do not accurately estimate the physical damage from cc and
- IAMs do not integrate financial markets, financial constraints, transition risks, chain reactions, social, political and geopolitical risks
What is the difficult in the relationship between transition and physical risks?
transition and physical risks interact in complex ways - effect different levels and result in a multitude of different kinds of risk
covid and supply chain disruption can all feedback into these changes - complex risk picture and cant capture that with a simple normal distribution
physical risks - changing and getting bigger and bigger as the climate is warming and the temperature implications etc.
What is the relationship between economic effects and physical environment extremes
shock such as an increase in the number of consecutive hot days
real GDP in the US declines in response to a positive temperature surprise
consumption and investment also shrink
What is the relationship between global warming and migration risk?
by 2050, cc could force more than 143 m people in 3 regions to move within their countries
core threat to the stability of a county’s economic sectors
+24 m people were newly displaced by sudden-onset of climate related hazards worldwide in 2016
WBG
- 3 largest displacement events in 2016 were climate related
How are climate change risks accounted for?
- Scenario-based forward-looking risk assessments
- huge uncertainty - regarding the effectiveness and timely deployment of new technologies
What are other appraoches that could be used to account for climate change risk that are not scenario-based forward looking risk assessments?
non-equilibirum agent-based models
socio-technical transition analysis
more complex scenarios
specific country, sector, firm case studies
carbon pricing alone cannot be the silver bullet to address the full complexity of climate change
Is a risk-based approach to understanding transition sufficient?
no need to acknowledge radical uncertainty and think in terms of system-wide transition
a pure risk based approach is simply not sufficient
What is the tragedy of the horizon and risks relationship?
we know that the risks are building up but they are not building immediately, by the time the risks materialise it will be too late, we need to find a way to avoid risks accumulating
What is the BoE Climate biennial exploratory scenario in 2021?
CBES
- asks major banks and insurers to estimate the size of the cc risks under 3 scenarios over 30yr horizon
- say how they would adjust their business models under each scenario
- BoE will provide macroeconomic targets and transition path
- builds on NGFS references scenario for central banks and supervisors
- a form of indicative transition planning
Have other central banks followed what the BOE has done in terms of the CBES?
- Bank de France, Australian Prudential Regulation Authority, and Bank of the Netherlands have done similar stress tests
ECB has conducted a macroprudential stress on climate risks
What do the CBES scenarios tend to look at?
early, late and no policy action over 30yrs
3x variables are being tacked - what losses are to be expected
gives the BoE an idea of the overall material risks associated with cc - from transition to physical risks
What are the takeaways from the CBES?
UK banks and insurers are making good progress in some aspects of their ciamte risk management, but they need to do more
the lack of available data on corporate current emissions and future transition plans is a collective issue affecting all participating firms
total losses depend on the scenario and the rate of decarbonisation related to this
early action scenario losses estimated to be 200bn in cumulative loss
late action scenario is estimated to be 300bn in cumulative loss
even bigger if BAU = idea that you are anti-growth if you do nothing
What would happen to carbon price in a late policy action scenario?
it would increase as carbon keeps accumulating
What can central banks do in addition to running stress tests?
mandatory disclosure of carbon emissions/footprint to enhance market discipline –> need better data to be able to de stress testing - source of disclosure from banks
financial regulation - the challenge is to shrunk bank carbon footprints while maintaining bank incentives to lend
carbon-weighting of assets –> risk weighting of carbon assets - risk weighted capital - idea if that if you have a riskless asset you are not supposed to hold equity against it as you face no losses = changes the way that central banks intervene as lenders of last resort
- tie divine payments to passing climate stress tests
augment living wills with stranded asset scenarios
- monetary policy - greening collateral frameworks
- net zero tragets for reserve asset portfolios
- consistency principles
what is a living will?
US companies have to disclose how they would deal with financial distress - how would they resolve their assets and how would it be broken up in the event of a large financial crisis and insolvency event
How does mandatory stress testing resolve the tragedy of the horizon
you are forcing banks to consider what would materialise after a big shock
living wills and stress testing forces big institutions to look to the future and consider the risks and how they would materialise
way of resolving the tragedy of the horizon
