Impact of climate risk on banks and expected credit losses

2024 Annual Report and Accounts  [extract]
Strategic report [extract]
Climate-related disclosures [extract]

We have continued to assess the potential Expected Credit Loss (ECL) impact from transition policy in our IFRS9 exercises, leveraging insights from our Climate Risk Macro Model(1), which has been embedded in our risk management processes since 2023.

We also refined our approach, instead of the economy-wide carbon price from an external scenario used in 2023, NatWest Group calculated the expected carbon prices associated with specific climate transition policies.

The current climate transition policy contributes £8 million to the total ECL of £3.4 billion at the end of 2024.

Annual Report 2024 [extract]
1.Accounting policies [extract]

Climate change impact on the Group’s balance sheet

Climate, and the impact of climate on the Group’s balance sheet is considered as an area which can impact accounting estimates and judgments through the uncertainty of future events and the impact of that uncertainty on the Group’s assets and liabilities. However, the Group has concluded that Climate Change does not have a financially material impact at this time.

The ESGR Risk team has performed a quantitative assessment of the impact of climate risk on the IFRS 9 ECL provision. This assessment has been performed across both the CIB and WRB portfolios. The Climate risk impact assessment on IFRS 9 business as usual ECL has been conducted based on newly developed and enhanced internal climate risk models for corporates across six priority sectors (Oil and Gas, Power, Steel, Mining, Shipping, and Automotive), one Generic model for the remaining corporate sectors and Sovereigns, while the top-down approach developed in 2022 was used for the remaining portfolios. The impact assessment, which primarily focused on transition risk, resulted in only a marginal ECL increase across CIB and WRB, which has been recorded as a management overlay for the 2024 year end.

Annual Report and Accounts 2024 [extract]
ESG review [extract]

Impact on our reporting and financial statements

We have assessed the impact of climate risk on our balance sheet and have concluded that no incremental adjustments were needed to capture climate impacts in our financial statements for the year ended 31 December 2024. The effects of climate change are a source of uncertainty. We capture known and observable potential impacts of climate-related risks in our asset valuations and balance sheet calculations. These are considered in relevant areas of our balance sheet, including expected credit losses, classification and measurement of financial instruments, goodwill and other intangible assets; and in making the long-term viability and going concern assessment.

Notes on the financial statements [extract]

(f) Critical estimates and judgements [extract]

Management has considered the impact of climate-related risks on HSBC's financial position and performance. While the effects of climate change are a source of uncertainty, as at 31 December 2024 management did not consider there to be a material impact on our critical judgements and estimates from the physical, transition and other climate-related risks in the short to medium term.

Annual Report and Accounts 2024 [extract]

Note 21: Allowance for expected credit losses [extract]

The climate risk assessments above remain limited due to the degree of uncertainty underpinning key assumptions used, as well as the continuing developmental nature of the data, approach and models used in the quantification. These include, but are not limited to, the analyses being restricted to PD impacts only; considering only the most material hazards for UK mortgages (flood and coastal erosion); client valuation impacts not incorporating climate transition plans; the physical risk modelling for corporates currently excluding broader components such as supply chain impacts, and more broadly the political landscape; future climate data enhancements and further model development.

The ECL impacts resulting from these climate risk assessments remain immaterial. This continues to support management’s view that there is a low residual risk of material error or omission in the Group’s financial statements due to climate-related risks and as a result no adjustments have been made to ECL measured as at 31 December 2024. The current behavioural lives of the Group’s lending reduces the potential exposure to the later emergence of potential physical climate impacts, with incorporation of climate risk, in credit policy, as a qualitative underwriting assessment within Commercial Banking credit process and origination process for mortgages providing further mitigation on more recent originations. 

Annual Report 2024 [extract]
Risk review [extract]
Risk performance – Credit risk [extract]

Climate Risk ECL Assessment

Barclays performed a credit risk assessment of physical and transition risk due to climate change. This was delivered through a combination of a scenario approach and targeted reviews on specific portfolios identified as more susceptible to climate risk.

Scenario Approach: The IFRS 9 Downside 2 scenario has been updated and aligned to the 2024 Internal Stress Test scenario which is climate aware, ensuring that climate is being considered within the modelled ECL output via existing macroeconomic variables.

Specific Approach: The approach reviewed portfolios previously identified from both internal and external stress tests as more susceptible to climate risks. In particular, new climate modelling techniques were utilised to inform customer level PD and LGD spreads of physical and transition risk due to climate change for i) the UK Mortgages portfolio (both PD and LGD), and ii) Certain elevated risk sectors (predominantly Oil & Gas, Aviation, Automotive and Power sectors) within the Wholesale portfolio (PD only). The output of this review did not provide variances in ECL deemed sufficiently certain to warrant raising an additional climate-related charge in 2024.

Annual Report 2024 [extract]
Notes to the Consolidated Financial Statements [extract]
2. Material Accounting Policies [extract]

Impairment Allowances on Financial Assets

Rabobank applies three-stage expected credit loss impairment models for measuring and recognizing expected credit losses, which involve management judgment. Rabobank uses estimates and management judgment to determine the expected credit losses for the model-based impairment allowances. In certain circumstances, Rabobank applies Management Adjustments (MAs) in addition to the model outcomes; these are described in this section. The MAs often require a significant degree of management judgment.

MA Climate Risk: Nitrogen

Nitrogen emissions are no longer allowed without a permit for projects such as housing development, construction and highway expansion since the ruling of the highest administrative court in the Netherlands in May 2019. The nitrogen reduction measures have impacted the whole of society, and the impact is particularly significant for farmers. Rabobank has acknowledged that for the current agricultural system change is needed. Sector visions have been updated incorporating goals in the areas of nature, water, climate, biodiversity and animal welfare during the period 2023-2040. As Rabobank finances a significant part of the agricultural sector, Rabobank is committed to support its agricultural clients through this transition towards a more sustainable sector. The Dutch government announced Nitrogen Plans for the Netherlands in June 2022, including emission reduction goals and prospects for farmers. Despite extensive negotiations involving numerous stakeholders - including an active contribution from Rabobank - an “Agricultural Agreement” has not been reached which resulted in uncertainty in the sector. Farmers in the livestock sector are scored on the profitability and sustainability of their business model, which determines the associated additional expected credit losses. As a result of improving the mentioned scoring of farmers and using better registered ‘Nitrogen Approach Program (PAS) reporters’ information, the MA decreased to EUR 23 million (December 31, 2023: EUR 47 million).

MA Climate Risk: Forward Looking Climate end Environmental (C&E) Risks

Risks are expected to mainly materialize in the future as regulation becomes more stringent (leading to transition risk) and the climate warms and becomes more extreme, increasing the probability and intensity of events such as droughts and floods (physical risk). The Climate Risk MA covers this chronic increase in future (forward looking) C&E risks and amounts to EUR 87 million (December 31, 2023: EUR 14 million). The MA covers the mortgage portfolio and the business loans portfolio.

The increase is mainly due to the increase in scope for the non-mortgages portion of the MA, which was extended to the entire business loans portfolio, compared to only climate sensitive sectors in December 2023. The countries and sectors exhibit different sensitivities to structural climate changes. These differences in C&E risks sensitivity is captured in different PD risk adjustment factors. However, even for non-climate sensitive sectors a climate impact is expected, though the impact will be limited. The scope of the climate risk sensitive sectors is based on the C&E Risks Heatmaps, where the five most relevant climate risk events (drought, wildfire, heavy precipitation, water scarcity and flooding) are used with a 5-10 year time-horizon.

Integrated Annual Report 2024 [extract]
Credit risk management [extract]

Climate and Environmental Risks in ECL
In this developing discipline, we are working to incorporate CER explicitly into ECL models. Following our roadmap, we are taking steps to gain deeper insight into how climate and environmental risks affect our clients, and to eventually embed them into our IFRS 9 ECL models.

Although the impact of climate risk on ECL can only be estimated with a high degree of uncertainty regarding amounts of losses and the time horizon on which it will materialize, it is partially embedded into our ECL estimates through our macroeconomic forecasts. Climate scenarios are included in Group Economics’ baseline, positive, and negative macroeconomic scenarios. These are underpinned by and compared to public and non-public climate scenarios such as those of the Network for Greening the Financial System (NGFS). To capture climate and environmental risks in ECL and related scenario processes, each macroeconomic scenario is accompanied by an overview that illustrates which of these risks are included in the various projected macroeconomic indicators.

For identifiable events with no or insufficient provisioning, ECL-related management overlays can be taken. We have taken two CER-related overlays: one for the potential impact the Dutch government’s nitrogen-reducing measures will have on our clients, which is related to environmental transition risk (EUR 29 million), and another for climate transition risk (EUR 19 million). Given the combination of macroeconomic scenarios and these management overlays, we consider the bank adequately provisioned for climate and environmental risks. For more details on these overlays, please see Individual and collective loan impairment allowances and management overlays in the Credit Risk Review section.

Consolidated Financial Statements Year ended 31 December 2024 [extract]
2.g Cost of Risk [extract]

The link between the macroeconomic scenarios and the measurement of the ECL is complemented by an approach allowing for the consideration of anticipation aspects not captured by the models in the generic approach. This is particularly the case when unprecedented events in the historical chronicle used to build the models occur or are anticipated, or when the nature or amplitude of change in macroeconomic parameters calls into question past correlations. Thus, the situation of high inflation and the level of interest rates previously recorded were not observed in reference history. In this context, the Group has developed an approach to take into account future economic outlooks when assessing the financial strength of counterparties. This approach involves projecting the impact of higher interest rates on customers’ financial ratios, notably considering their level of indebtedness. Credit ratings and associated probabilities of default are revalued based on these simulated financial ratios. This approach is also used to anticipate the effect of lower prices of commercial properties. Starting in 2024, this approach is also used to complete a prospective assessment of potential consequences of climate change (transition and physical risks) on credit risk for corporate counterparties and mortgages. At the end of 2024, physical risks are accounted for through a post-model adjustment.

Annual Report 2024 [extract]
Note 20 Expected credit loss measurement [extract]

The tests used were based on a set of assumptions and methodologies from a mainstream leading climate model vendor and complemented by the Network for Greening the Financial System (NGFS) (2023) climate pathway scenarios. Such analysis undertaken during 2024 as part of a regulatory climate scenario analysis exercise mandated by FINMA concluded that the counterparties are not expected to be significantly impacted by physical or transition risks, mainly as there are no material risk concentrations in high-risk sectors. The analysis of the corporate loan book has also shown that any potential significant impacts from transition costs or physical risks would materialize over a time horizon that exceeds, in most cases, the contractual lifetime of the underlying assets. The analysis and its results are also subject to challenges in model assumptions, calibration, and heightened model uncertainty, as are other climate models in the novel discipline of climate risk modeling. Based on current internal modeling exercises, this conclusion holds for the portfolio of private clients with mortgages and the portfolio of real estate financing.

As a result of the aforementioned factors, it was assessed that the magnitude of any impact of sustainability and climate risk on the weighted-average ECL would not be material as of 31 December 2024. Therefore, no specific post-model adjustment was made in this regard.

Annual Report 2024 [extract]

Risk and Capital Management [extract]
Credit Risk Management [extract]

IFRS 9 Model Results

Provision for credit losses was €1.8 billion in 2024, up from €1.5 billion in 2023 and 38 basis points (bps) of average loans, in line with the guidance the bank provided after the third quarter. The increase was driven by cyclical events in the Commercial Real Estate sector, certain larger corporate credit events, and temporary effects following the Postbank integration. The wider portfolios performed broadly in line with expectations despite the challenging macroeconomic and interest rate environment.

With regard to climate risks, estimates of higher transition and physical risk exposures and their impact on the Expected Credit Loss (ECL) did not result in any adjustment of credit loss provisions for the years ended December 31, 2024, as well as December 31, 2023.