Climate Change Risk and the Performance of South African Banks

Climate Change Risk and the Performance of South African Banks

Babatunde Samuel Lawrence, Mishelle Doorasamy
DOI: 10.4018/978-1-7998-7967-1.ch023
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The comprehensive climate risk index (CRI) is used to proxy climate change risk in this chapter as an independent variable alongside control variables such as credit risk/nonperforming loan (CRISK), total asset (TA), leverage (LEV), net income margin (NIM), capital adequacy ratio (CAR), yield on earning assets (YEA), and gross domestic product (GDP). Return on assets (ROA) as the response variable was used as proxy for performance of the top six listed South African banks on the Johannesburg stock exchange. Using Stata in a multiple regression technique for the period 2006 to 2019, this chapter concludes that the CRI is negative but not significant enough to impact performance of banks; however, its different individual components such as drought index, rain-waterlogged, etc. could be computed and regressed with other profitability measures to investigate their impact on performance of the banks in future editions of this book.
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In credit risk management, development of new climate risk product, and climate-related financing and investment, the bank’s role can never be overemphasised. However, on the adverse side, banks could face credit risks because policies to cut emissions can give rise to high costs for carbon-intensive industries and firms. Volatility in the price of carbon markets (such as coal, CO2, oil and gas) and climate-related commodities gives rise to uncertainty in financial projections (Dlugolecki & Lafeld, 2005).

Financial risks associated with climate change have intensified at all levels of most financial sectors in the last couple of years. At the microlevel, banks and the financial system’s smooth operation and efficiency have been threatened, while at the macrolevel, the entire stability of the financial system is exposed to considerable risk. For example, it was established that over the last decade more than $140 billion has been expended on natural disasters which is far more than the amount spent in the past three decades and additionally, over 300% increment in extreme weather events has occurred around the world (NGFS, 2020). Claims from insurance firms around the world are also estimated to be over 100% by 2085 due to increased frequency in the occurrence of events emanating from extreme weather or climate conditions (NGFS, 2020).

This has significant consequences for the financial sector while cases of extreme events as a result of distorted climate and weather conditions have occurred. An increase in these conditions is also expected soon. Hence, tackling financial risk, as a result of changes in climatic conditions, with the present monitoring and supervisory frameworks, has become very relevant. The banks in different countries have increased supervisory expectations which are centred on identifying and managing their climate-related financial risk (Feridun, 2020).

Recently, studies on climate change have focused on the existing and imminent risk for banks (Klomp, 2014; Dafermos, Nikolaidi & Galanis, 2018) and the transition costs on banks (Cui, Geobey, Weber & Lin, 2008; Huang, Unzi & Wu, 2019). On the other hand, Caldecott, Harnett, Cojoianu and Kok (2016) have investigated the financial stability of banks with respect to climate change.

There is constant pressure on banks to react to the risk of climate change. However, timeliness in receiving information that will aid in capital allocation, time management and other management tools would assist banks to be adequately prepared against climate change risk. Significant business investment has been estimated to resolve climate risk change, with global figures in the tune of US$150 billion per year in 2010 to US$1 trillion per year by 2030 (Jolly, 2010; UN Global Compact, 2009).

South Africa, as one of the emerging economies, projected a 20% decrease in per capita consumption as a result of climate change risk on the economy while the underdeveloped countries in Africa face a potential adverse impact of climate change, compared to other economies in the continent, because of their economic, social and environmental factors. This is because the underdeveloped economies in Africa are mostly prone to high hydroclimatic challenges (Chevalier, 2010; Houghton, 2009; Munashinghe & Swart, 2005; Schulze, 2005). This indicates an urgent necessity for an empirical study in the South African context. Moreover, conflicting studies on both companies and banks have been submitted with regards to sustainability and their financial information on climate change. Visser (2002), and Domingues, Lozano, Ceulemans and Ramos (2017) report that financial information on sustainability and climate change continues to improve on an average level. Blignaut and De Wit (2004), Burns and Weaver (2008), and Soyka (2012) posit that this information is not commonly analysed, disclosed or used in decision-making for the profit of the financial system.

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