"Having awareness is one thing—now we need to move into action."
PLANET
For Gerhard Mulder’s birthday on July 3, he was gifted with a bitterly ironic present: it was (at the time) the hottest day ever recorded globally. The irony, it must be clarified, lies in the fact that Gerhard is the CEO and co-founder of Climate Risk Services, an organization dedicated to providing companies with the data, insights, and know-how necessary to combat climate risk-related issues.
Gerhard Mulder
CEO and co-founder of Climate Risk Services
As the world enters what the UN Secretary General labeled the “era of global boiling”—following on the heels of the World Meteorological Organization announcing that July 2023 was the hottest month ever recorded—the focus on climate risk for financial institutions (FIs) is also reaching higher levels. According to the 11th Annual EY/IIF Global Bank Risk Management Survey, 91% of CROs and 96% of boards see climate change as a top emerging risk—nearly double the amount of CROs in 2019.
For Gerhard, that’s not enough. “Having awareness is one thing—now we need to move into action. That means really implementing robust risk management frameworks and integrating it into your strategy, and understanding the metrics and targets that will allow you to steer your balance sheet away from being brown and at high risk to green and low risk.”
of boards see climate change as a top emerging risk
But what exactly is climate risk? And why should banks and financial institutions care about it?
No bank wants to sit on risk on risk that they don’t understand or aren’t monitoring, but most importantly aren’t being compensated for. This, of course, begs the question: why has climate risk not receive the same level of attention other types of risks banks work to mitigate?
For years, climate change has been delegated to the status of something along the lines of a distant abstraction—or a bit of a blind spot, as Gerhard puts it. Climate change was accepted as a real threat, but a future issue to be dealt with down the road. That time has passed. With the very real effects of climate change looming down on us all, the Paris Agreement is being taken more seriously.
Now, there are two types of climate risks banks face. The more visible is physical risk: clients facing climate-induced droughts, hurricanes, water stress, or other phenomena that could increase the likelihood of a loan default. The less obvious risk is transition risk: risks associated with moving towards a decarbonized economy—and yes, there are risks with going green. For example, policies curbing GHG emissions could affect a bank’s client’s strategy, increase their overall costs, or disrupt the markets they operate in, threatening business continuity.
But it’s not only banks that are paying attention: now, central banks and regulators see climate change as the threat to the stability of the global financial system. The transitions risks are present everywhere, and the fear is that a sudden shift to a decarbonized economy could wipe billions or trillions of off-balance sheets worldwide. For example, one of FMO’s customers supporters, I&M Bank Kenya, received technical assistance from FMO through a NASIRA portfolio guarantee, leading to their partnership with Climate Risk Services—which came about in part due to increased pressure from Kenya’s central bank. From Egypt to Morocco to Mauritius, central banks are starting to ask banks, at minimum, to disclose their climate-related risks.
Gerhard explains: “What we see is that central banks are asking the same core questions: What are your risks in your loan book, and what are you doing about it? And that’s why embedding climate risk frameworks into your strategy is important—because those frameworks help you answer those questions.”
That said, there are other key drivers for banks to start incorporating climate risks into their risk management systems. Financial institutions in the Global South—like FMO’s client I&M Bank Kenya—often have a relationship with a multilateral development bank or development finance institution like FMO, which are pushing for transparency on climate risks. These institutions are also increasingly providing more assistance and capital to power the green economy, which means that down the road, banks that don’t now capitalize on this new opportunity of green financing may find themselves shut out of the system.
By transferring knowledge to financial institutions through a mix of data analytics and advisory services, FIs can be empowered to independently manage climate risks as quickly as possible.
On the data analytics side: say an agricultural farm discovered they were operating in an area with an expected increase of water stress. The client could reduce the water stress by offering tailored adaptation solutions, like creating water retention pumps for irrigation down the road. In turn, these could be financed through green lines of FMO or other DFIs.
And on the advisory side: “If banks start to incorporate climate risk into their risk appetite framework: this means they can start monitoring these risks. If certain thresholds are breached, they can then start to take strategic actions through, for example, capacity building to start proactively managing these risks.”
Although, Gerhard stresses, a key challenge for banks and FIs (no matter where they are located) is fully owning climate risk and not treating it as a corporate social responsibility topic, which often means starting in the ESG department. “It’s a financially material topic, and companies should have their Chief Risk Officer oversee this kind of work—which is also what central banks want to see. And although it should be spearheaded by the CRO, a core challenge is making sure the whole organization is on board and not just a small sub-unit.”
All that said, transitioning to a zero-carbon economy will come with hefty transition risks. FIs, banks, or corporates with a client portfolio across multiple industries and sectors may have extended supply chains in countries more prone to climate change, which will lead to evolving financing needs down the road.
While all governments must adhere to overarching climate goals, a just and inclusive transition requires that countries that have historically emitted the most must assume the highest responsibility. Development finance institutions in the Global North can encourage these opportunities, further developing unbankable opportunities into bankable projects with concessional financing and technical assistance to motivate new clients to start decarbonizing—which FMO does, for example, through market creation as part of its updated 2030 Strategy.
Despite having spoken about various challenges inherent in tackling climate risk, there’s an even bigger challenge that needs to be tackled, Gerhard posits at one point in the conversation: the nigh-ubiquitous struggle of truly seeing climate change as a material risk, even though it exacerbates credit, market, technology, and operational risk.
It’s not a shortage of capacity, or data, or insights. It’s a shortage of imagination.
In his own words: “Our own mental model is the problem: it’s not a shortage of capacity, or data, or insights. It’s a shortage of imagination. Because once you see it, there’s no going back.”
To visualize that, he references the FedEx logo, which he explains includes a hidden symbol signifying what the company stands for. It’s harder to spot than expected: even knowing that you’re looking for something hidden doesn’t make it too easy to find it.
“But if you look between the E and the X, there’s the white arrow,” he explains. “And once you see it, you can’t unsee it.”
Instantly, it’s blindingly obvious, to the point it seemed impossible to have imagined not having been able to it. And therein lies the core of Gerhard’s thesis: once you truly see climate change and its effects, it becomes impossible to unsee them. Cognitive dissonance is no longer a choice.
But despite all the challenges, hurdles, uncertainty, and doubt that looms ahead, Gerhard remains surprisingly at ease, confident that the international DFI and MDB space is well-poised to unlock the trillions in financing needed to decarbonize economies. Perhaps its because of his 25 years of experience in the climate risk sector. Perhaps it’s something less palpable, like his deliberate choice of words, laced with a faint hint of a smile which seems to speak to an undercurrent of ever-present optimism. Whatever it is, it is contagious.
“If you’re a bank in the Global South, it’s time to prepare yourself, because the floodgates of green capital are really about to open,” he says. “A lot of green capital is coming your way.” If CRS lives up to its mandate, Gerhard envisions a world in which, by 2030, climate risk has been truly embedded into all financial institutions through a top-down approach, and that these organizations feel supported by ventures like CRS or FMO in their decarbonization journey. “Success to me means that in 2030, brown banks are either non-existent or practically irrelevant. Green banks all around.”
2030 is still a ways off. But there’s plenty to do in the meantime: all partners on the playing field—from financial institutions to Climate Risk Services to DFIs—must join forces to bend the curve and decarbonize as we collectively transition towards net-zero economy
All as we prepare for a slightly hotter world.