This article was first published in ASEAN Bankers Association’s Apr/May 2022 newsletter.

To say that 2021 was transformative in how banks look at climate change will not be an overstatement. After decades of wallowing primarily as a corporate social responsibility (CSR) or public relations (PR) concern, climate change is now getting embedded as a strategic priority for businesses and has found its way into the performance targets of senior bank leaders. Singaporean banks, in particular, acted quickly to address the issue, with Malaysian banks also following swiftly. The journey of the Singaporean and Malaysian banks probably forebodes what lies ahead for other institutions in the ASEAN region.

By the end of the 2010s, all Singaporean banks had sustainability teams focused on climate and corporate banking teams focused on green assets. Green investments had been scaled up to anywhere between USD10 to 25 billion as opportunities in renewables and green real estate became clear. Green bonds and sustainability linked loans were issued. However, at an overall level, green finance remained a small part of the business.

As banks recovered from the pandemic relatively unscathed, action on the climate front accelerated. Driven partly by investor, regulatory, and peer pressure, banks in Singapore have started investing in three main areas. The first is incorporation of climate financial risk in their risk framework – particularly in risk appetite, underwriting, and the risk organization. This change was accelerated by new MAS guidelines that banks are expected to comply with in 2022.

Climate risk quantification using scenario analysis has been the second major area of investment. Our quantification work with several South East Asian banks has had major strategic implications, helping identify mispricing in brown assets and accelerating the transition towards greener assets and more transition focused clients. Banks will benefit from investing in this capability early. These insights are expected to feature prominently in banks next iteration of Task Force on Climate-Related Financial Disclosure (TCFD) aligned reports.

The third major area of investment has been the development of a Net Zero strategy. This takes them beyond “green financing” into a realm where strategy will assume the real economy is transitioning to low or no carbon technologies. This opens the discussion around transition finance, knowing 20 to 40% of assets banks currently hold will look very different in a decade. Underlying the shift in the assets is an assumption that governments and consumers will transition the real economy towards Net Zero as well. If this assumption comes true, banks that embark on the Net Zero transition in their books will emerge as clear winners. However, if governments and consumers continue to drag their feet on climate change, there might be opportunity costs for the banks moving their assets to Net Zero.

Despite this risk, we believe banks at this stage have little choice but to start to align their portfolios. External pressure will continue to mount – investors now consider a Net Zero commitment to be table stakes, and international bodies like the Glasgow Financial Alliance for Net Zero (GFANZ) are now turning their attention to Asia. Even regulators are adding pressure – Bank Negara Malaysia’s draft guidelines encourage banks to set emission targets and to consider climate risk in capital calculation. Almost all the other ASEAN nations have introduced climate risk guidelines.

There is also the strategic view that sooner or later, the real economy will transition to no or low carbon technologies. Banks that fall behind that transition will lose out. Given this context, we believe banks should start investing in building their Net Zero strategies, albeit with appropriate diligence and caution.

Based on Oliver Wyman’s experience of doing this work with multiple banks, here are five key lessons for banks that are starting this journey:

Start board and senior management education and budgeting now

The depth of climate change knowledge required across board and senior management is very material, and it may not be present as evenly today. Moreover, successful climate programs will cost banks anywhere from USD5 to 25 million and result in major strategic changes. Regulatory and investor push will help immensely in getting “hearts aligned”, but banking leaders will need to invest in building knowledge and capabilities to get the momentum required.

Get CEO sponsorship and build an integrated program

Climate programs will have material profit and loss implications and will affect teams across Risk, Compliance, Wholesale Banking, and Finance. This is especially so for corporate banks, but also in retail banks where the focus is on new opportunities to help customers live a greener life. While the programs can be championed by the respective leaders of those departments and coordinated by a Strategy or Sustainability team, success can only be achieved through CEO commitment and sponsorship. Further, one integrated, well-coordinated program across these functions should be built as there will be strong overlaps in what different teams must do in terms of the emissions data used, and the combined implications of financial risk and emissions objectives on the strategy.

Start early, especially on stress testing and Net Zero

While divergent across institutions, these capabilities have now matured. Starting early will help your bank overcome the challenges that lie ahead more effectively – especially when data and knowledge build-up takes time. Moreover, it will give you a head start in accessing the new growth opportunities, especially in the space of transition and adaptation finance.

Plan an “organizational” transformation

Climate change will transform the way business is done across a large number of verticals. For example, your energy sector relationship managers will need to be well-versed in the emissions of coal versus gas, and the costs of various carbon capture technologies. Your Risk function will need new underwriting tools to incorporate climate effects. This transformation will come with the challenges typical to any organizational transformation – managing change, people, investments, etc.

Plan for an evolutionary program

The scope of climate risk will grow exponentially over time and engulf more sectors. Five years ago, financial risk from climate change was highly muted. Today, we can already observe mispricing in sectors like power and mining. Given the complexity of the task ahead, banks will be wise to use the materiality leeway offered by most regulators and focus on the sectors with most material risk and opportunities to start with, and then expand over time.

Climate change now has real risk and strategy implications. While the task ahead is daunting, it remains within reach and quick movers will certainly be strongly positioned in the future.