Today’s environmental changes are a whole new world of risk for banking lenders and borrowers. We should have seen this coming.
Two decades ago, researchers identified the tipping point in Earth’s atmosphere: 400 parts carbon dioxide per million parts air in Earth’s atmosphere. What was once called “global warming” is now full-blown Climate Change. This blog post presents the case that the complex of adverse environmental impacts from climate change pose an extraordinary risk and a long-term liability for bank lenders.
The Proof, Naturally
In the run-up to this event, beginning more than a century ago, we have witnessed:
- Massive loss of continental ice, adding to sea level rise and erosion of coastal communities and tourism attractions worldwide;
- Mega-forest fires and severe drought in the U.S., from California to the Carolinas;
- Historically heavy rainfall, flood-driven landslides in the Northwest and ocean flooding in New York City;
- Prolonged heat waves and drought reducing agricultural yields and lowering water tables in over three-quarters of the contiguous United States.
- Intermittent snowfall in ski resorts;
- Unprecedented river flooding in the Mississippi basin;
- Widespread destruction of Western U.S. forests from invasive insects;
- Unpredictable weather events, such as ice storms in Southern U.S. cities.
- The uncertainty about forthcoming events is itself a risk, a palpable shadow of doubt for investors and lenders that support economic growth.
A New World of Risk
Whether climate change is natural or induced by humans—evidence says, both—is academic. With the accelerating force and frequency of weather events, lenders and borrowers experience the impacts first hand. From the banker’s standpoint, more frequent natural disasters and indiscriminate destruction is the glaring red flag of RISK: unpredictable, uncontrollable, slowly recoverable events for borrowers and lenders alike.
The Office of Comptroller of the Currency (OCC), U. S. Treasury Department, regulates national banks and federal savings associations. One of the key tasks of the OCC is to monitor risks that may impact a bank’s operations, practices, liquidity, strategy, continuity and importantly: reputation. However, the OCC, Federal Emergency Management Administration (FEMA), Small Business Administration (SBA), Congress, nor the President can readily mitigate the multiple risks of climate change. Banks must adapt with customized, responsive financial services that adjust to new, more frequent risks. This is the future of lending in the new world of climate change, and it is called Resilience.
Re: The Resilience Quotient
Ballantine Environmental Resources developed this equation showing the relationship between real-life variables that impact resilience. Consider two lending scenarios:
1. Traditional lending. A bank loans to a real estate developer. He has had success in the past, developing in the traditional way: placing commercial buildings, industry and low cost housing along the riverside; a school at the edge of the prairie; and dense residential neighborhoods nestled in overgrown, unmanaged pine forest on the hillsides. The largest homes with the best views are perched on hilltops and buttes. Two years after project completion, tornadoes rake the exposed hills and destroy a swath of hilltop homes. Four years after project completion, lightning strike ignites an uncontrolled forest fire, incinerating entire woodland neighborhoods. In the winter rainy season, the waterlogged hillsides erode, damming the nearby creek. This causes flooding throughout the community.
This community is declared a Disaster Area. Several homeowners return to rebuild, but many do not. Flood and fire insurance does not fully cover the losses. The developer files for bankruptcy. The bank is faced with a significant write down of huge loss. This project has a low RE value: low P (performance financially) due to significantly high-risk exposure (R) over time (T).
2. Resilient Lending. A bank loans to a real estate developer. This loan performs profitably over the full term because the borrower has done her RA—Resilience Assessment, an advanced form of due-diligence required by the astute bank loan officers and insurers. She chose a building site on well drained, rolling topography far beyond the region’s 1,000-year floodplain. The property is located on ground that is not eroding or waterlogged, not underlain by abandoned mines, radon-bearing rock, or fracking lines. Her site is safely distant from adverse exposure: wildfire-prone forest, or historic tornado or hurricane pathways.
This developer has created a successful community. She trains her sales and marketing staff to pass on knowledge of the environment and how the development was begun only after careful risk assessment. She has done her homework. The real estate market responds favorably. She pays her loan to her bank 18 months in advance. She has limited her exposure to risk and suffered no losses to natural or manmade impacts. She has created resilience, and it is profitable for her and the bank.
A New Focus
The successful developer meets again with her lender. Now the bank does its due diligence and adopts resiliency-risk criteria for all its investments. The developer studies new property with a Resilience Assessment company and, after deep investigation and analysis, determines that this new location has low risk, short and long-term. The lender commits to funding, based on its Resilience Criteria. The developer begins planning, always on the lookout for opportunity to eliminate or minimize risk. She stays deeply involved in the sales, administration, and management of the community; and reports regularly to the bank. This protects the lender’s investment and represents the interests and wellbeing of those who choose to build homes, raise families, and start businesses. The new community manages its risks and thrives. The bank manages its loan and charts the success of resilient investment.
Lending is the lifeblood of community. It is crucial that banks formulate their comprehensive Financial Resilience Strategy (FRS)—a “Lender’s Marshall Plan” that guides and protects investments in the threatening uncertainties of climate change. Fully assess the conditions. Identify every risk, present or potential. Promote recovery—economic, social, and environmental. Lend for ventures that revitalize community and commerce in this era of great challenge and opportunity. This is the future. It is named Resilience.
For more information about Resilience Assessment contact:
Environmental Resiliency Expert
Ballantine Environmental Resources, Inc.