The finance and banking industries is one of the largest sectors of the U.S. economy. This industry category includes commercial banks, investment banks, stock exchanges, and other firms involved in capital raising, wealth management and related research services. The industry is very large. For example, commercial bank assets in the U.S., which are comprised of loans and leases, investment securities, cash and other assets, totaled $11.8 trillion in 2009 based on gains of 7.1% per year from 2004 (Freedonia1 2010).
Physical Exposure Risk. The industry is not characterized by large numbers of physical assets, thus its physical exposure is negligible. Some retail-focused banks do possess large networks of brick-and-mortar locations, which are often not situated on the coast. Mass migration of populations as a result of flooding or desertification is always a risk in worst-case scenarios, albeit they remain a highly localized event. Given the above, the risk of physical impacts on banking assets is negligible.
Policy & Regulatory Risk. The fortunes of the banking and investment sectors are intimately tied to the fortunes of the industries these invest into. Investment firms may begin – as some already do – modeling the effects of potential global carbon market developments on the economy (Deutsche-Bank 2011). Other regulatory developments, such as the move made by the Securities & Exchange Commission to encourage firms to disclose material risks related to climate change, will enable investment firms to better assess systemic portfolio risks. However, it is not expected that financial firms will be affected directly by domestic or international policies aimed at mitigating or adapting to climate change. As a result, policy or regulatory risk is very low.
Reputational Risk. The cost of offsetting actual carbon emissions is minimal allowing banks to limit easily reputational cost (Llewellyn 2007). As a result, most banks are expected to pledge carbon neutrality goals and improve the energy efficiency of their headquarter buildings and retail locations. In the investment arena, asset managers and professional investors have responded appropriately to market needs by developing investment portfolios or indices – such as the Dow Jones Sustainability Index – that allow clients to invest in companies with strong environmental performance. Banks and investment firms have for the most part avoided significant reputational risks by lending to industries that are large contributors to GHG emissions. As evidenced until now, reputational risk is negligible because the public places the onus on individual firms and not on the firms that lend to these.
Competitive Risk. Banks in general do not stand to be beneficiaries of climate change to the extent that economic conditions worsen as a result (Llewellyn 2007). Banks are broadly exposed to the whole economy, principally the corporate and household sectors, thus the industry is geared to the gross domestic product. The key risk to commercial banks earnings is credit quality, or rather, the inability to appropriately assess risk in the face of unknown and unpredictable systemic risks caused by climate-related negative events (Llewellyn 2007). Investment banks, on the other hand, in their role as allocators of capital, will likely benefit from any rapid technological change. Venture capital, a type of investment firm focused on early-stage startups, now invests over 10% of available capital on renewable energy. Banks may also profit from trading GHG-emission reduction credits and commodities influenced by weather-related volatility. Based on the complexity of the risks and opportunities in this industry, the competitive risk is high.