In an era where climate change has become an ever-looming spectre, the financial industry finds itself at a crossroads.
As the mortgage sector grapples with the growing uncertainty brought about by climate risk, it is imperative to understand the profound implications this phenomenon carries.
Climate risk, ranging from extreme weather events to shifting property values, poses significant challenges to both lenders and borrowers.
To weather this storm, the mortgage industry must swiftly adapt by integrating climate risk assessment into its operations, adhering to evolving regulations, and embracing sustainable lending practices.
Central banks take the lead
In a groundbreaking move, the US central banking system is taking proactive steps to assess the true magnitude of financial risks posed by climate change and the banks' capacity to mitigate them.
The Federal Reserve's board is conducting a pilot climate scenario analysis exercise to learn about large banking organisations' climate risk-management practices and their ability to identify and manage climate-related financial risks.
Although the initial pilot tests have faced criticism for not fully evaluating real exposure to climate risks, they underscore a vital shift in the financial sector's trajectory.
Banks are keenly aware of the imperative to not overlook risks that are increasingly becoming central to their peers' decision-making processes and business strategies.
It underscores the growing significance of comprehending the high-risk assets within their portfolios and devising effective risk-management strategies.
Adding to the pressure, regulatory authorities are intensifying their scrutiny.
Last year, the Fed announced the inaugural climate stress test for six of the nation's largest banks, compelling them to adopt a more earnest approach to climate change considerations.
With the financial sector now taking decisive steps, the broader economic ecosystem will inevitably follow suit.
Property managers, for instance, must recognise that their access to capital hinges on banks' assessments of new risks, which might be distinct from their own perceptions.
Insurance industry at a crossroads
Meanwhile, the insurance sector is tackling the challenge of evaluating and pricing climate risk, leading to increased premiums and even policy cancellations for borrowers.
A glaring example unfolded in the US involving two major players, State Farm and Allstate.
In a watershed moment in May 2023, the nation's largest first and fourth property and casualty insurance firms jointly declared their decision to halt the issuance of new home insurance policies in California, citing, among other factors, the spectre of extreme weather events.
These seismic announcements reverberated across the globe, shining a spotlight on the rapidly evolving dynamics between the world's financial institutions and the ever-changing climate.
The mortgage industry is not immune to these challenges either.
As the impact of physical climate risks amplifies insurance pricing, homeowners find themselves saddled with soaring premiums, often hampering their capacity to meet mortgage obligations.
When property values plummet due to climate-related threats, borrowers face a daunting hurdle in securing favourable mortgage terms or even qualifying for them.
