The recent Los Angeles wildfires are only the latest reminder that banks need to steel themselves against climate change both in their portfolios and in their own businesses.
The wildfires are expected to be one of the most costly natural disasters in the United States and already rank among the worst natural disasters in California. Several fires in the Los Angeles area destroyed or damaged more than 16,000 homes and buildings. Twenty-nine people died as a result of the blazes. The two largest fires, the
Some estimates put the final damage tally at
“Banks, financial institutions and insurers all have significant financial risk, and the fires in LA are just the most recent example,” said Steven Rothstein, managing director of the Ceres Accelerator for Sustainable Capital Markets, noting it may potentially rank as the most expensive extreme event in U.S. history. “To put it in context, in the 1980s, NOAA said our country had a $1 billion event — fire, flood, tornado — every three months; now we’re getting them every week and a half.”
Ceres, a nonprofit organization that works with capital market leaders, has produced several studies on the effects of climate change on the banking industry. The group advocates for sustainability in capital markets.
“That extreme weather has an enormous impact. For a bank, it could affect their customers, it could affect their suppliers, their customers’ suppliers,” Rothstein said. “As we all learned during COVID, the supply chain is very intertwined, and an impact in one place can impact someplace else. We believe that there needs to be more awareness of these risks and steps need to be taken.”
The issue of climate change
Analyses of the January fires by the
“Climate change increased the risk of the devastating LA wildfires,” said Clair Barnes of the Imperial College London, the WWA study’s lead author. “Drought conditions are more frequently pushing into winter, increasing the chance a fire will break out during strong Santa Ana winds that can turn small ignitions into deadly infernos.”
Concern for the effect climate change will have on the financial sector has existed for years. A 2021
The Federal Reserve last May released the
It found that the largest banks could see an increase in loan defaults caused by climate change and the decarbonization of the economy. A few months earlier, the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of Currency
President Donald Trump has already begun to unwind many of the climate efforts implemented under the Biden administration and set the tone for banks to follow suit. Earlier this month the Fed’s Board of Governors voted to
How should banks respond?
Risk management is the first place to start. Ceres’ Rothstein said he recommends banks look at their customers sector by sector to determine exposure.
“The biggest risk is not whether the bank branch will survive. That’s a very small financial risk in the context,” he said. “The fundamental question is, are they asking their customers about the risks that they have? What are their customers doing to prepare?”
Laurent Birade, banking industry practice lead at Moody’s, agreed, noting the recent fires emphasize the “urgent need for financial institutions to prioritize climate risk management.”
“Similar to the impact of Hurricane Milton and Helene last year, these fires are likely to cause additional financial strain in the insurance and reinsurance sectors, leading to increased reinsurance rates,” Birade said. “Banks with significant exposure to impacted sectors in their loan portfolios must understand, identify, measure and manage their climate risk exposure through scenario analysis to ensure more resilient and sustainable financial operations.”
Birade said there is additional risk stemming from the potential for
“Banks should proactively assess and mitigate this impact by diversifying their portfolios and engaging in strategic risk transfer mechanisms,” he said.
Rothstein said it’s easier for larger banks to diversify their risks than small and medium-sized institutions. He said there have been cases where weather events have caused smaller community and regional banks to close completely.
“Considering that the overwhelming majority of banks are small and medium-sized, many of them are even more at risk because they’re more concentrated,” Rothstein said. “Bank of America – they have a very diversified loan portfolio, so God forbid, if there’s a fire in one city or a flood, it’s awful, but it’s not going to affect them financially in the big picture … But if you’re the Bank of Los Angeles, you could have a very large percentage of your loan portfolio affected.”
Chris Stanley, another banking industry practice lead at Moody’s, said banks need to consider the multifaceted nature of the risk that climate disasters pose.
“When confronting catastrophes like the LA wildfires, understanding exposure, supporting customers, and positioning credit-loss reserves become critical challenges for bankers,” Stanley said.
Dan Saccardi, program director for the Ceres Company Network, a group of 50 major corporations that work with Ceres to implement sustainable practices, said the organization has conducted studies looking at both the physical and transition risk that climate change poses to banks. It found banks are beginning to measure and understand risks but they are still underappreciated.
“Over time, they could grow to as much as 10% of banks’ loan portfolios, if they’re not properly addressed,” Saccardi said. “And while the major U.S. global banks can certainly absorb that, and also are much more diversified, some of the smaller subregional banks or community banks are highly invested within specific geographic regions, such that they could have very significant portions of their residential and commercial loan portfolios impacted by an event like the wildfires we’ve just seen or the flooding we saw in North Carolina in the fall of last year.”
Looking forward
Saccardi said while there is much to be done to hedge against climate change, there are many opportunities as well.
Understanding the risks posed to certain sectors and clients, banks have an opportunity to engage with them on a products and services level, he said. Financial institutions can offer resilience and mitigation-focused lending to clients to ease risks, and there’s also revenue-generating product and service opportunities for banks to help customers finance plans to fortify their physical infrastructure.
Advances in analytics and AI will ease the burden by both assisting with risk management and helping financial institutions to identify and aid their customers most in need, Stanley predicted. “Banks will use these tools to more rapidly and confidently support their communities in the aftermath of this tragedy.”
Birade said banks should focus on strengthening their business continuity plans “to ensure operational resilience in the face of these types of climate-related disruptions.”
“Physical climate risk management is becoming a strategic necessity for banks aiming to navigate the financial challenges posed by an increasingly volatile climate,” he said.
Jay Ribakove is a principal at Convective Capital, a group dedicated to investing in entrepreneurs developing technology to prevent and address severe wildfires. He said there is opportunity for banks to help the insurance market minimize risk and price risk appropriately.
Convective Capital invests in companies offering solutions to address wildfires when they do break out and to mitigate risk. The options available, Ribakove said, depend on what consumers are trying to protect.
For homeowners and businesses, there are solutions including home hardening and introducing defensible space around the property. If a fire does break out, there are companies offering technologies for early detection to prevent fires from becoming more extreme.
“Even within the prevention and suppression landscape, we need numerous tools because the problems are very different. Fighting a traditional wildfire in a remote area is very different than an urban configuration like what we saw in Los Angeles,” Ribakove said. “We’re seeing a lot of new investor interest in this space, and that means we have a lot of work to do supporting the companies that we’ve already invested in.”
These new ventures to address the growing global climate shift also need to be financially backed. Rothstein said banks can benefit from the investments.
“Last year, the world spent around $2.2 trillion on emerging and new technologies, renewables, and a variety of other things — that’s grown dramatically over the last few years, and it’s projected to grow to $4 to $5 trillion a year — and all of that needs to be banked,” Rothstein said. “It’s a big business opportunity.”