Assessing credit risk and opportunity in a changing climate: Outputs of a working group of 16 banks piloting the TCFD Recommendations PART 2: Physical risks and opportunities July 2018 Navigating a New Climate | 2 NAVIGATING A NEW CLIMATE Assessing credit risk and opportunity in a changing climate: Outputs of a working group of 16 banks piloting the TCFD Recommendations PART 2: Physical risks and opportunities July 2018 CONTENTS Perspectives from the working group ........................................................................................................... 3 Acknowledgements ........................................................................................................................................... 5 Disclaimer ............................................................................................................................................................ 6 Project introduction .......................................................................................................................................... 7 Executive summary ........................................................................................................................................... 8 1. Introduction: Preparing banks for the impacts of a changing climate ........................................... 11 2. An integrated approach for physical risk assessment .......................................................................13 2.1. Borrower characteristics ..............................................................................................................15 2.2. Insurance as a risk mitigant for extreme climate and weather events ...............................15 2.3. Climate change scenarios .............................................................................................................17 2.4. Climate change impacts on probability of default ...................................................................21 2.4.1. Assessing changes in sector productivity ..........................................................................................21 2.4.2. Adjusting income statement metrics ..................................................................................................23 2.4.3. Determining changes in probability of default ...............................................................................25 2.5. Real estate: Climate change impacts on loan-to-value ratios ...............................................26 2.5.1. Estimating impacts of extreme events on property values ................................................... 26 2.5.2. Determining changes in loan-to-value ratios ..................................................................................27 3. Operationalizing the approach: Lessons learned from bank piloting ...........................................28 3.1. Bank #1 case study: Agriculture ..................................................................................................29 3.1.1. Introduction ...................................................................................................................................................... 29 3.1.2. Analysis of a representative sample of borrowers ..................................................................... 29 3.1.3. Stress testing the sample ...........................................................................................................................30 3.1.4. Segment stress sensitivities .......................................................................................................................31 3.1.5. Sector portfolio results / findings ..........................................................................................................31 3.1.6. Lessons learned, challenges and the way forward .......................................................................32 3.2. Itaú Unibanco case study: Physical risk in the agriculture sector .........................................33 3.2.1. Introduction ......................................................................................................................................................33 3.2.2. Methodology ....................................................................................................................................................33 3.2.3 Application of the methodology...........................................................................................................34 3.2.4. Results .................................................................................................................................................................. 36 3.2.5. Lessons learned, challenges and the way forward .......................................................................37 3.3. TD Bank Group case study: TD and Bloomberg collaborate on testing the use of geospatial mapping for physical risk assessment......................................................................38 3.3.1. Scope ....................................................................................................................................................................38 3.3.2 Assessment method: Bloomberg MAPS ..........................................................................................38 3.3.3 Results ..................................................................................................................................................................43 3.3.4. Conclusion .........................................................................................................................................................43 3.4. UBS case study: Assessing physical climate risk to electric utilities companies ................44 3.4.1 Approach ...........................................................................................................................................................44 3.4.2. Benefits and challenges ..............................................................................................................................44 3.4.3. Potential next steps/areas of future work ........................................................................................45 3.5. Standard Chartered case study: Commercial real estate in China ......................................46 3.5.1. Background and scope of analysis ........................................................................................................ 46 3.5.2. Approach adopted for analysis .............................................................................................................. 46 3.5.3. Results and impact assessment ...............................................................................................................47 3.5.4. Areas of further work identified ..........................................................................................................48 3.3.5. Conclusion .........................................................................................................................................................48 Navigating a New Climate | Contents 1 3.6. RaboBank case study: Getting physical with Dutch real estate ............................................49 3.6.1. Scope .................................................................................................................................................................... 49 3.6.2. Challenges and workarounds ................................................................................................................. 49 3.6.3. Analysis and outcome .................................................................................................................................50 3.6.4. Key takeaways and challenges .................................................................................................................51 3.6.5. Other observations .......................................................................................................................................52 4. Physical opportunities: Exploring an institutional strategy ..............................................................53 4.1. Taxonomy of opportunities and data sources ..........................................................................54 4.2. Assessing the market .....................................................................................................................56 4.2.1. Sector finance demand assessment .................................................................................................... 56 4.2.2. Sector assessment ..........................................................................................................................................57 4.3. Assessing a bank’s institutional capacity and market positioning .........................................59 4.4. Evaluating opportunities ................................................................................................................60 5. Future directions: Towards the next generation of physical risk and opportunities analysis .. 62 5.1. Developing in-house analysis and capacities within banks .....................................................62 5.2. Strengthening the research base .................................................................................................64 5.3. Developing analytical platforms and tools to support physical risk and opportunities assessments ............................................................................68