About
Through leveraging the scenarios and time horizons from the Bank of England’s Biennial Exploratory Scenario, and our climate product, ON Climate – OakNorth became one of the first banks globally to stress test its loan book against climate change risk.
Innovation presentation
Climate change is a grave global issue that impacts us all and we are now at a critical juncture where it can no longer be ignored. The National Oceanic and Atmospheric Administration (NOAA) released its annual research on 2021 climate events at the start of the year, reporting that there were 20 weather and climate disasters that caused $1B or more in damage in the US alone. Collectively, these events caused over $145B in damage – an astounding figure. NOAA’s research also shows that the average number of annual billion-dollar events continues to increase – with an average of 17.2 over the past five years, compared to 5.3 during the 1990s.
Given these alarming figures, it has become critical for commercial lenders to assess how material and manageable their climate change exposure is. To do this, lenders must look to gather more data, and conduct quantitative and qualitative scenario analysis – a key reason behind the development of ON Climate, which OakNorth Bank used in 2021 to undertake a granular scenario analysis of the possible impact of climate risks on its borrowers and capital requirements.
ON Climate, part of the ON Credit intelligence Suite, provides US commercial lenders and OakNorth Bank in the UK, with insights on climate risk in their commercial portfolio that can inform their approach to every stage of the credit lifecycle: from origination and monitoring, to conducting portfolio-level scenario analysis, responding to investor, board, and regulatory requests, as well as setting credit strategy. Its forward-looking climate scenarios are constantly updated with the most recently available data, including high frequency third party data sets, to ensure its bank partners have the most accurate view of climate impact across their portfolio.
Furthermore, it enables OakNorth Bank to make faster and smarter decisions on which borrowers or sub-sectors in its portfolio are most likely to suffer or benefit from climate change, and as a result, mitigate risk and identify origination opportunities to lend more. By using traditional and non-traditional data sources, the credit technology also enables OakNorth Bank to better understand climate risk with a holistic, forward-looking view of the ever-changing and evolving landscape around climate issues.
Uniqueness of the project
ON Climate is a SaaS application that was developed by OakNorth’s team of credit scientists and software engineers, in close collaboration with 10 US banks and 27 climate experts.
It applies six scenarios that are aligned with the Network for Greening the Financial System’s (NGFS) climate scenarios, and the Paris Accord, and the May’21 US Executive Order. These scenarios are evaluated through the lens of three transition pathways:
• AN ORDERLY TRANSITION (i.e., where policy action starts immediately/in the near term)
• DISORDERLY TRANSITION (i.e., where policy actions are delayed until 2030)
• HOT HOUSE WORLD (i.e., where there are no further policy actions). And across four-time horizons: 5, 10, 20, and 30 years
ON Climate then applies the scenarios to our repository of 273 sub-sector forecasts, covering 963 6-digit NAICS codes, to assess carbon emission impact from policy actions and supply chain disruption at a very granular sub-sector level. In addition, ON Climate provides forecast financials and credit metrics at the borrower level – under each of the climate scenarios and time horizons. These outputs can be directly inputted into to banks’ existing risk rating models to drive a climate-adjusted risk rating.
Borrower data
Banks can easily run robust and dynamic analysis to determine climate impact and emissions using existing borrower datasets. ON Climate overlays six climate scenarios on 14+ borrower data points, that can be readily extracted from your spreading and core banking systems, to provide a forward-looking climate risk score from low priority (least vulnerable) to high (most vulnerable).
Climate risk
ON Climate covers transition risk assessment at the granular sub-sector level. In the future, the solution will be extended to encompass the physical risks of climate change as welL
Transition risk
To arrive at a risk score, the ON Climate solution identifies the borrower level impact metrics that influence the revenue (driven by shift in demand or disrupted operations) and costs (supply-chain driven operating costs, capital expenditure for clean or remediating technology) along with policy driven impact for borrowers and uses those to project the future financial health and potential risks their business may face.
Physical risk
ON Climate’s physical risk assessment will evaluate how extreme weather events such as floods, drought, and hurricanes can lead to business disruption and damage to property. It will also address how longterm changes in climatic patterns, such as rising temperatures, change in precipitation, increasing sea levels, desertification, etc. can affect labor, capital, and agricultural productivity.
Climate risk score
ON Climate also provides banks with an overview of their climate risk and distributed exposure across top sectors and borrowers for their commercial portfolios. For example those with:
• Lower projected climate risk, in sectors that are rated to have inherently high climate risk.
• Borrowers with high climate risk that you might be able to coach to help avoid future risk
Financed carbon emissions reporting
ON Climate helps banks calculate and report on Scope 3 financed emissions across their commercial loan portfolio. The solution follows the Partnership for Carbon Accounting Financials (PCAF) guidelines when calculating GHG emissions and applies the PCAF’s Score 3 and Score 4 methodology. This allows banks to view the total financed emissions in loan book by portfolio and individual borrower level.
Financed carbon emissions
ON Climate provides commercial lenders with the total financed emissions for their commercial loan portfolios split by:
• Total scope 3 financed emissions
• Financed emissions (Scope 1 and Scope 2) by sector
• Financed emissions (Scope 1 and Scope 2) for each borrower
Taking a holistic view of financed emissions—together with carbon pathways under the various NGFS scenarios—enables banks to evaluate and set overall emission goals (e.g. net zero by 2050), and understand the levers available to manage a transition of their commercial portfolio.
Apply climate insights across a bank’s full credit lifecycle
ON Climate provides banks with insights on climate risk in their commercial portfolios that can inform their approach to every stage of the credit lifecycle: from origination and ongoing monitoring, to conducting portfolio level scenario analysis, responding to investor, board, regulatory requests, and setting credit strategy.
