The Effects of Climate Change in Financial Industry and Banking Sector (Term Paper Sample)

The Effects of Climate Change in the Financial Industry Name: Institution: Table of Contents TOC \o "1-3" \h \z \u The Effects of Climate Change in the Financial Industry PAGEREF _Toc415682159 \h 3 Introduction PAGEREF _Toc415682160 \h 3 Climate Change Events that Affect the Financial Industry PAGEREF _Toc415682161 \h 3 Climate Change and the Banking Sector PAGEREF _Toc415682162 \h 4 Climate Change and the Insurance Sector PAGEREF _Toc415682163 \h 7 Discussion of Findings PAGEREF _Toc415682164 \h 10 Conclusion PAGEREF _Toc415682165 \h 11 References PAGEREF _Toc415682166 \h 13 The Effects of Climate Change in the Financial Industry Introduction Climate change is an emerging global concern that has massive implications on the functioning of the entire society. Besides affecting the social wellbeing of humans, the effects of climate change influence the political and economic spheres too. The financial industry is at the core of the global economy. Specifically, financial institutions play an instrumental role with respect to providing the global population with capital and identifying as well as managing investment related risks and opportunities. These are vital aspects that influence decision making and general operations in the financial sector and the economy at large. As indicated earlier, climate change is an important phenomenon that presents both risks and opportunities for exploration in by the financial industry. According to Labatt and White (2007), the effects of climate change on this sector can be either indirect or direct. Since financial institutions are at the center stage of the global economy, the effects of climate change that affect them spill over to the economy too. In order to minimize risk and seize opportunities in a timely manner, it is important for the financial industry to understand the nature of the direct and indirect effects of climate change. It is against this background that this paper provides an in-depth evaluation of the effects of climate change in the financial industry. Climate Change Events that Affect the Financial Industry Climate change is characterized by extremes in weather events and temperatures. Oxley (2012) indicates that global warming results into hot and lengthy summers. Increased temperatures have direct effects on crop and animal production and business operations. In addition, it affects land subsidence as well as mortality and morbidity trends amongst humans. The changes in air quality are caused by rising temperatures and have direct impacts on human and animal health. The effects of the rising temperatures influence decision making of financial institutions in different ways. Cold temperature extremes are likely to become rare due to global warming (Rudyk, Stewart & Kingsbury, 2009). In temperate regions, these changes have positive impacts on various sectors including construction, and transport. In addition, the changes are unlikely to have any noticeable effect on business operations. Although the temperatures are unlikely to remain low, changes in precipitation will be expected. Thus, incidences of heavy snow fall, severe storms and flooding will rise. Heavy rainfall and flooding culminate in various economic losses that have diverse implications on the financial sector. Global warming leads to low rainfall and increased incidences of wildfire and drought (Mills, 2009). This affects the financial industry because of the impacts that it has on building foundations and commercial agriculture. The risks that relate to the abovementioned hazards affect decisions and operations in the financial sector directly. Also, extra tropical and tropical windstorms are likely to be experienced more often due to climate change (Mills, 2009). Undisputedly, the damages that are associated with these events are significant. They impose immense pressure on human health, resources, and infrastructure. Finally, the rise in sea level causes flooding and increases the occurrence of tidal surges. The losses of property and lives that are associated with this event are enormous. The financial industry assumes the responsibility of managing the losses, repairing infrastructure and compensating institutions and individuals accordingly. Climate Change and the Banking Sector In his research, Bowman (2013) indicates that banks play a leading role in helping the population to adapt to the implications of climate change. By developing risk mitigation products, lending individuals and institutions financial resources during critical times, formulating credit risk management policies, and making vital investment decisions, banking institutions empower populations to adjust effectively to climate change. The impacts of climate change to the banking sector are both negative and positive. In addition, they are both direct and indirect and impose costs as well as provide opportunities for the banking institutions. Climate change has direct impacts on project financing as well as corporate banking (Bowman, 2013). To begin with, the current policies that relate to mitigation of climate change expose banks to credit risk. In particular, policies that aim at reducing emission of greenhouse gases transfer business risks to the global economy. The regulations undermine the credit worth of carbon intensive institutions and therefore expose banks to related risks because the banks play an important role of financing the affected institutions. In addition, the banks share a mutually benefiting relationship with the institutions and as such, any financial challenges that face the institutions have spillover effects on the banks. The policies’ costs of compliance affect the companies as well as consumers of their products. The affected sectors such as the energy industry and cement manufacturers struggle with additional costs that have negative effects on their financial stability. This has implications for banks that play important roles as project financiers, lenders, and equity investors (Bowman, 2013). Further, banks face various operational risks that stem from poor internal risk assessment processes. In most instances, these culminate in inappropriate evaluation of carbon related impacts. In some instances, Rudyk et al. (2009) argues that poor risk evaluation is influenced by the volatile nature of the carbon related policies. Inappropriate risk management by affected firms results into financial sanctions that have far reaching effects on the financial wellbeing of the affected institutions. In particular, such incidences affect the liquidity of the clients adversely and compromise the credit worth as well as competitiveness of the banks too. Directly, the effects of climate change such a severe storms and flooding have negative impacts on corporate assets and real estate. In his review, Bowman (2013) estimates that severe weather destroys corporate assets of worth 3,800 billion US dollars each year. In addition changes in weather patterns result into uncertainty in the utility sector. The changes increase the costs of energy that are used by the corporate buildings that are occupied by the banks. As indicated earlier, mitigation policies impose additional costs to banking institutions and other parties in the financial sector. Noncompliance to them has severe repercussions including blacklisting. Resultantly, this has detrimental effects on the reputation of the affected institutions as well as on their ability to access and benefit from credit. In addition, investing in controversial energy projects such as nuclear power exposes banks and their clients to reputational risks (Oxley, 2012). In this regard, it is worth appreciating that the current consumer base place great emphasis on environmental protection and restoration. Association with controversial projects has negative effects on the sustainability of banks. It influences the decisions, operations, and perceptions of clients negatively. What is more, the policies require banks to participate actively in corporate social responsibility activities relating to environmental protection. Relative initiatives require financial resources and intensive capacity building (Oxley, 2012). Labatt and White (2007) posit that the effects of climate change also present financial institutions with opportunities for sustainable growth and development. In this respect, adaptation of corporate institutions to the changing energy environment and compliance with the policy regulations presents banks with opportunities for growth because the initiatives require financial involvement. Specifically, the affected sectors require low carbon technologies and purchase of renewables. Banks can explore these opportunities and ensure that they reap optimal outcomes. However, Labatt and White (2007) argue that it is important for them to understand the long term risks that may be related to the investments. At this point in time, it cannot be disputed that climate change has diverse effects on the poor facet of the population. The effects cause them to seek for financial resources in order to protect themselves against the negative impacts of future occurrences and repair damages that are associated with the same. These present banks with opportunities to offer innovative microfinance services. Besides providing the affected population with financial resources, banks offer a broad array of products including savings and insurance. Climate Change and the Insurance Sector The effects of climate change are likely to have massive implications on the activities and operations of insurance firms. Essentially, professionals in this field are responsible for investigating risks including those that are related to climate change. Recent trends indicate that seemingly, insurance firms are incurring increased costs that relate to damages caused by the effects of climate change such as severe storms and flooding (Oxley, 2012). The effects...