Week 5

Question 1

Why are banks important to consider?

Answer 1

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

Question 2

Is there pressure on banks to decarbonise?

Answer 2

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

Question 3

Is there any evidence of banks acc decarbonising?

Answer 3

• 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

Question 4

Is there any evidence of banks decarbonising their portfolio in relation to physical risk?

Answer 4

• 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

Question 5

Is there any evidence that banks are decarbnoising their portfolios in relation to transition risks?

Answer 5

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

Question 6

Does bank decarbonisation trigger real adjustments in the companies that they lend to?

Answer 6

• effect on corporate real and finanical decisions - GHG emissions
• green firms benefits more from green banks

Question 7

Why do banks commit to net neutrality?

Answer 7

= 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

Question 8

What are some particular characteristics of bank’s commitments to net neutrality?

Answer 8

• 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

Question 9

What condition (of two) does a firm have to be considered exposed to a committed bank?

Answer 9

• 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

Question 10

Why do we look at the syndicated loan market?

Answer 10

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

Question 11

What is a lead arranger?

Answer 11

in a syndicated loan system there is a leader that in a sense organising the gathering of sources of capital for the syndicated loan

Question 12

When was the SBTI established?

Answer 12

2015

Question 13

How many US banks made SBTi commitments in the 5yrs post SBTi establishment?

Answer 13

0

the pressure is greater in europe therefore European banks are more likely to make commitments

Question 14

How did the paris agreement impact the commitments by banks to the SBTi?

Answer 14

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

Question 15

How has company exposure to commited banks changed over time?

Answer 15

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

Question 16

Is there a geographical distribution of firms that are exposed to committed banks?

Answer 16

no it is a global phenomena
of ~2100 companies 60% were exposed to committed banks

consistent with the idea of global banks

Question 17

Why is the US interesting?

Answer 17

No US banks are committed but US make the largest percentage of companies in the sample and are the largest exposed to commitments

Question 18

What is the effect of high emissions and an exposure to a bank committing

Answer 18

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

Question 19

Do banks also respond to changes in scope 2 and 3 - why or why not?

Answer 19

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

Question 20

Is the non-banking sector taking up the slack in potential business from banks restricting their lending?

Answer 20

nope

there is no compensation in credit coming from the non-banking sector

the effect is a drop by 12 percentage points

Question 21

What is the total effect across banks and non-banks on high emissions companies?

Answer 21

12 percentage point reduction in capital available to the firms

Question 22

Can you explain the differences in extensive and intensive margins in the context of bank lending?

Answer 22

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

Question 23

What impact has bank commitment had on intensive and extensive margins

Answer 23

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

Question 24

What kind of banks make commitments?

Answer 24

multinational banks

small number but their impact is big due to the large fraction of companies that are exposed to them

Question 25

What is the demand side story for the reduction in banks giving debt to brown industry?

Answer 25

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

Question 26

What is the supply side story for banks not lending to brown industry?

Answer 26

the company has demand for debt but the banks don’t want to lend

Question 27

How could you use Chevron as an example of how to eek out whether the supply or demand side story dominates?

Answer 27

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

Question 28

So in summary what are the three ways you can use loans to look at the impact of committed banks?

Answer 28

• 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

Question 29

From the loan level results what force is the most pressing?

Answer 29

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

Question 30

What does the loan-level evidence tell us about syndicated markets?

Answer 30

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

Question 31

What is a good way of measuring whether the interest on loans changes for brown firm loans?

Answer 31

Can’t observe the price of each loan therefore can look at income statements - companies report an interest expense

Question 32

Why would it be interesting to look at interest rates?

Answer 32

Banks could respond by increasing the interest for loans to brown rather than green industries

Question 33

What is the effect of banks commitment on the interest expense?

Answer 33

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

Question 34

Do firms internalise credit shocks in their decisions?

Answer 34

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

Question 35

Do firms respond to bank pressure by changing their decarbonisation and ESG activity?

Answer 35

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

Question 36

What is actually changing post shock of committed banks to the MSCi score?

Answer 36

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

Question 37

What does the return on asset evidence tell you about what firms are doing in response to pressure from committed banks?

Answer 37

The story is that the companies are choosing profitability over carbon footprint

Question 38

Is there a re-allocation of bank debt to green companies?

Answer 38

Yes the opposite of what is happening with brown companies is happening to green companies - they are receiving greater credit and investing more

Question 39

What is a rationale for why profitability might be more valued than emissions reductions or ESG?

Answer 39

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

Question 40

Are banks changing their behaviour towards emissions?

Answer 40

• 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

Question 41

How do firms internalise the pressure of banks?

Answer 41

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

Question 42

What is the role of central banks?

Answer 42

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

Question 43

What are macro-prudential policies?

Answer 43

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

Question 44

What is stress testing?

Answer 44

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

Question 45

When was the great financial crisis?

Answer 45

2007/9

Question 46

What were the consequences of the great financial crisis?

Answer 46

central bank introduced new policy tools like stress testing and focused on facilitating resolution to avoid bailouts

Question 47

How was cliamte changed considered prior to the great financial crisis?

Answer 47

• 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

Question 48

How as cliamte change considered post great financial crisis?

Answer 48

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

Question 49

What was the impact of covid on the financial markets

Answer 49

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

Question 50

How did lenders of last resort intervene in the financial crisis associated with covid?

Answer 50

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

Question 51

What is the difference between the fed and ECb’s mandate?

Answer 51

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

Question 52

What was the momentum consequences of paris agreement for central banks?

Answer 52

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

Question 53

What does the NGFS do?

Answer 53

• 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

Question 54

What concept do supervisoers use to measure risk?

Answer 54

value at risk

Question 55

What is value at risk?

Answer 55

• 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?

Question 56

What are some of the issue with how cc is currently being assessed and who said that?

Answer 56

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

Question 57

What is the difficult in the relationship between transition and physical risks?

Answer 57

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.

Question 58

What is the relationship between economic effects and physical environment extremes

Answer 58

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

Question 59

What is the relationship between global warming and migration risk?

Answer 59

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

Question 60

How are climate change risks accounted for?

Answer 60

• Scenario-based forward-looking risk assessments
• huge uncertainty - regarding the effectiveness and timely deployment of new technologies

Question 61

What are other appraoches that could be used to account for climate change risk that are not scenario-based forward looking risk assessments?

Answer 61

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

Question 62

Is a risk-based approach to understanding transition sufficient?

Answer 62

no need to acknowledge radical uncertainty and think in terms of system-wide transition

a pure risk based approach is simply not sufficient

Question 63

What is the tragedy of the horizon and risks relationship?

Answer 63

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

Question 64

What is the BoE Climate biennial exploratory scenario in 2021?

Answer 64

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

Question 65

Have other central banks followed what the BOE has done in terms of the CBES?

Answer 65

• 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

Question 66

What do the CBES scenarios tend to look at?

Answer 66

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

Question 67

What are the takeaways from the CBES?

Answer 67

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

Question 68

What would happen to carbon price in a late policy action scenario?

Answer 68

it would increase as carbon keeps accumulating

Question 69

What can central banks do in addition to running stress tests?

Answer 69

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

Question 70

what is a living will?

Answer 70

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

Question 71

How does mandatory stress testing resolve the tragedy of the horizon

Answer 71

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