Climate Transition Risk in U.S. Loan Portfolios: Are All Banks the Same?

51 Pages Posted: 2 Mar 2021

See all articles by Quyen Nguyen

Quyen Nguyen

CEFGroup & Department of Accountancy and Finance, University of Otago

Ivan Diaz-Rainey

CEFGroup & Department of Accountancy and Finance, University of Otago

Duminda Kuruppuarachchi

University of Otago - Department of Accountancy and Finance

Matthew McCarten

University of Oxford - Smith School of Enterprise and the Environment

Eric K. M. Tan

University of Queensland - Business School

Date Written: December 1, 2020

Abstract

We examine banks’ exposure to climate transition risk using a bottom-up, loan-level methodology incorporating climate stress test based on the Merton probability of default model and transition pathways from the IPCC. Specifically, we match machine learning predictions of corporate carbon footprints to syndicated loans initiated in 2010-2018 and aggregate these to loan portfolios of the twenty largest banks in the United States. Banks vary in their climate transition risk not only due to their exposure to the energy sectors but also due to borrowers’ carbon emission profiles from other sectors. Banks generally lend a minimal amount to coal (0.4%) but hold a considerable exposure in oil and gas (8.6%) and electricity firms (4.6%) and thus have a large exposure to the energy sectors (13.5%). We observe that climate transition risk profile was stable over time, save for a temporary (in some cases) and permanent (in others), reduction in their fossil-fuel exposure after the Paris Agreement. From the stress testing, the median loss is 0.5% of US syndicated loans, representing a decrease in CET1 capital of 4.1% but this may grow twice as large in the 1.5oC scenarios (1.4%-2.1% of loan value, 12%-16% of CET1 capital) compared to the 2oC target (0.6%-1.1% of loan value, 5%-9% of CET1 capital) with significant tail-end risk (7.7% of loan value, 62% of CET1 capital). Banks’ vulnerabilities are also driven by the ex-ante financial risk of their borrowers more generally, highlighting that climate risk is not independent from conventional risks.

Keywords: bank risk; climate risk; corporate loans; syndicated loans; stress testing

JEL Classification: G17; Q51; Q52; Q54

Suggested Citation

Nguyen, Quyen and Diaz-Rainey, Ivan and Kuruppuarachchi, Duminda and McCarten, Matthew and Tan, Eric K. M., Climate Transition Risk in U.S. Loan Portfolios: Are All Banks the Same? (December 1, 2020). Available at SSRN: https://ssrn.com/abstract=3766592 or http://dx.doi.org/10.2139/ssrn.3766592

Quyen Nguyen (Contact Author)

CEFGroup & Department of Accountancy and Finance, University of Otago ( email )

P.O. Box 56
Dunedin, Otago 9010
New Zealand

Ivan Diaz-Rainey

CEFGroup & Department of Accountancy and Finance, University of Otago ( email )

Dunedin
New Zealand

Duminda Kuruppuarachchi

University of Otago - Department of Accountancy and Finance ( email )

PO Box 56
Dunedin, 9054
New Zealand

Matthew McCarten

University of Oxford - Smith School of Enterprise and the Environment ( email )

United Kingdom

Eric K. M. Tan

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

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