Managing the impact of climate change on credit risk

We assisted a mutual bank to understand and measure the exposure of its residential lending portfolio to physical climate risk under a range of climate scenarios, including the impact on credit risk.

The Challenge

The bank wanted to understand whether its mortgagees would be exposed to increased costs of natural perils due to climate change, and the potential impact on credit risk carried by the bank.

The bank did not have access to detailed information about the current or future risk of weather-related extreme events on properties provided as securities for home loans, and had not performed a physical climate risk assessment before. The bank wanted to address APRA’s expectations that regulated institutions understood and managed the potential financial risk from climate change.

The Solution

We used our perils models to estimate the current and future cost of natural perils for every property in the portfolio both today and under two different climate scenarios, consistent with APRA’s expectations. We estimated the impact of the increase in home insurance premiums for each mortgagee on both the serviceability of each loan, and the market value of the underlying property security. This provided the bank with a view of the impact of climate change on credit risk on the portfolio under potential climate scenarios. We produced a report that could be used as part of the bank’s disclosures to its members and to APRA on climate risk management.

The Business Impact

The Bank is now able to demonstrate to APRAA and its members that it is in step with market leaders in the assessment of the impact of climate change on credit risk and to develop strategies to manage this risk over time.