Banks’ response to loan losses caused by the impact of climate change could include tighter loan-to-valuation ratio limits and reduced lending in regions and to industries impacted by emerging risks. This is a key takeaway from the Australian Prudential Regulation Authority’s Climate Vulnerability Assessment, its first attempt to measure the extent and severity of climate change impacts on the financial system and individual financial institutions. The CVA is based on data and analysis supplied by ANZ, Commonwealth Bank, Macquarie Bank, NAB and Westpac. Its focus is on credit risk, “as this was considered the most readily measured and material transmission channel of climate risk for the banks”. Analysis was based on two scenarios: a delayed transition scenario, where there is delayed policy action on climate and then more rapid action after 2030; and a current policies scenario, which envisages increasing global emissions beyond 2050. An APRA information paper released yesterday says climate change will increase banks’ lending losses measurably but they are likely to be able to absorb the impact. “Lending losses would be impacted under the climate scenarios that were evaluated. However, in the absence of a severe deterioration in macroeconomic conditions, these losses are unlikely to rise to a level that would result in severe stress for the banks. “But the potential for higher losses arising from climate change could lead to the banking sector being more vulnerable to future economic downturns.” APRA said there was significant variability in lending losses across banks. This was due to different modelling, the level of detail in the data used and differences in business mix. Regional factors and exposure to certain industries also played a part. Mortgage portfolio results showed losses up to three times historic averages. Risks included higher levels of default after climate events and damage to property that reduces the value of collateral. Business loan losses “were observed to rise substantially in both scenarios.” In response to the potential for higher lending losses from climate change, the banks modelled adjustments to their risk appetites. This included tightening loan-to-valuation ratio limits in high-risk areas and reducing lending in some regions and to some industries. APRA said the CVA is a work in progress, with data quality and accessibility “a challenge”. It said banks will have to invest in developing their capabilities to improve assessment of their exposure to climate risks.