The Financial Industry Could Lose Up To Us$1 Trillion If It Fails To Respond To Climate Change

Feb 20, 2020

Financial institutions can reduce risk and increase earnings potential by reallocating capital to green companies and investments


LONDON – The financial industry could lose up to $1 trillion in the event of major policy shifts that aim to slow climate change, such as levying a carbon tax. However, banks, insurers and asset managers have the opportunity to reduce these risks and increase their earnings potential by reallocating capital to greener companies and investments. Those that move fast will be best placed to capture the growing revenue pool, which today is worth $40BN globally but is expected to grow to $US100-150 billion as transition financing and sustainable investing grow.

This is according to “Climate Change: Three Imperatives For Financial Services,” a new report by Oliver Wyman, the global management consultancy. The report finds that while a growing number of banks are making steps to reallocate capital, fewer than 10 per cent of the industry have a robust data-driven approach to do so. Banks can’t risk falling behind. Previous studies have estimated that the green economy will require up to US$6 trillion of capital mobilised in the coming years.

The report highlights three recommendations that banks must follow in the face of climate change:

1.       Act on the risks. The report looks in depth at the potential impact of a carbon tax, estimating it could drive credit losses of up to $1TN, and explores other climate risk types. While much is uncertain, it is clear that these risks are material. And yet few firms are systematically factoring them into decision-making today.

2.       Seize the opportunity. The report profiles the market in sustainable finance and estimates 100bn+ in new revenue potential, across investing, financing, data and advisory. Those able to move fast and work across boundaries to shape the evolving market are best placed to win.

3.       Steer top down. Investor, customer and regulator pressure on financial firms is increasing in many markets. To get ahead of this, firms need to act proactively to steer capital and show progress in reducing the carbon intensity of the portfolio. More fundamentally, this is an opportunity for the industry to playing a leading role in one of the defining issues of our time.

James Davis, Partner and a lead author of the report, said: “The financial industry can have a significant impact on accelerating the transition to a green economy by proactively steering capital towards the businesses and technologies that will drive it. Our analysis shows that there are strong commercial reasons to act – the financial risks are material and need to be incorporated into decision-making, while sustainable finance is one of the most promising areas for revenue growth in the industry at the moment. This is an opportunity for the industry to lead.”

Ted Moynihan, Global Head, Financial Services, added: “The important thing now is that the industry moves into action. The work is complex, there are many competing frameworks, and there are important data gaps. It’s clear that the risks and opportunities are large enough to make this a priority for management teams. There’s a lot to be done working bottom-up to adjust the machinery of the organisation, and this needs to be complemented with strong top-down direction setting.”


About the analysis

The analysis modelled the impact of a carbon tax. In order to arrive at US$1 trillion figure, we focused our analysis on two of the most affected sectors, power generation and oil & gas, with a tax level of about US$50 /tCO2 eq. Together, they account for ca. 40 percent of global greenhouse gas emissions. The results showed that on average, probability of default increases two to three times in these sectors, with a highly differential impact across borrowers, both within and across sectors [see figure 3 in the report]. This could result in US$50 billion to US$300 billion in losses on outstanding debt across both sectors. By extrapolating the figures to the broader economy, we estimate as much as US$1 trillion could be at risk.

About Oliver Wyman

Oliver Wyman is a global leader in management consulting. With offices in 60 cities across 29 countries, Oliver Wyman combines deep industry knowledge with specialized expertise in strategy, operations, risk management, and organization transformation. The firm has more than 5,000 professionals around the world who work with clients to optimize their business, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is a wholly owned subsidiary of Marsh & McLennan Companies [NYSE: MMC]. For more information, visit Follow Oliver Wyman on Twitter @OliverWyman.