BANKING IMPERATIVES IN ACHIEVEING A CLIMATE RESILIENT WORLD

“Change or be changed, right? And what we mean by that is that climate change, if we don’t change course, if we don’t change our political and economic system, is going to change everything about our physical world.” Naomi Klein.

A.??INTRODUCTION

In two (2) days’ time, Egypt will host the 27th Conference of Partners on Climate Change-COP27. This event is expected to take place from 6th to 18th November, 2022. At this conference, Parties to the United Nations Framework Convention on Climate Change intend to build on the outcomes of?COP26 to deliver action on a number of issues. These include: urgently reducing greenhouse gas emissions, building resilience to adapt to the inevitable impacts of climate change and delivering on the commitments to finance climate action in developing countries.?

Beyond doubt, we are faced with a growing energy crisis, record greenhouse gas concentrations and increasing extreme weather events.?Kenya is currently experiencing the worst drought in 40 because of climate change.?However, despite the glaring effects of climate change, most have not fully appreciated the magnitude of the crisis we are in.

Following the Glasgow COP26, Kenya and other Countries are required to submit the actions they have taken to reduce greenhouse gas emissions and how they intend to build resilience to adapt to the impact of rising temperatures.

Previously, financial institutions did not involve themselves in climate change debates and action. This was probably because climate change was communicated more as a scientific problem rather than an issue within the purview of financial regulation. However, owing to the growing concern of the effects of climate change, there is dire need for everyone, including financial institutions, to uphold environmental standards. Also, and perhaps most importantly, a growing number of financial institutions have realized that financing fossil fuels and other projects that harm the environment is bad for their long-term future.

Indeed, the 2021 Basel Committee’s[1] Report on climate related risk factors and transition channels suggests that financial institutions are exposed to these three distinct types of climate risks:

????i.???????Physical risk arising from damage or loss to collateral assets caused by climate and weather related events;

???ii.???????Transition risk arising from the shift to a lower-carbon economy. These arise through changes in government policies, technological developments, or investor and consumer sentiment;

??iii.???????Liability risk arising from banks being sued for financing companies who harm the environment.

A.??CENTRAL BANK OF KENYA GUIDANCE ON CLIMATE-RELATED RISK MANAGEMENT

It is against the above backdrop that the Central Bank of Kenya (CBK) issued the Guidance on Climate Related Risk Management (Guidance) to the Banking sector in October, 2021.

The Guidance requires all financial institutions to have an effective governance structure to enable them effectively identify, manage, monitor and report the risks that they are or might be exposed to which includes:

???i.?????Oversight- By the Boards over the institutions exposure and responses to climate related issues and ensuring climate-related risks are embedded into the institution’s risk management framework.

???ii.???????Strategy- Financial Institutions are expected to understand the impact of climate-related effects to the business so as to formulate a short, medium and long term strategy that addresses climate-related issues. In addition, financial institutions are required to ensure the effective implementation of their strategy by aligning internal resources and managing relevant changes.

?iii.?????Risk management- Financial institutions should establish an effective risk management process that can identify, monitor, report, control and mitigate climate-related risks. This should be based on a comprehensive assessment on how climate change is likely to affect the institutions portfolios and operations.

Who bears the responsibility for implementation of the Guidance?

The Board of Directors and Senior Management are responsible for the formulation and implementation of the climate-related financial risk management strategies, policies, procedures, guidelines and the set minimum standards for an institution.

Consequences of non-compliance with the Guidance

Section 33 (5) of the Banking Act provides the following penalties for non-compliance with the Guidance:

????i.???????For the financial institution- a fine not exceeding Kshs. 100,000/=,

???ii.???????For officers of the financial institution- a fine of Kshs. 50,000/= or imprisonment for a term not exceeding 2 years or both,

??iii.???????Such additional penalty as maybe prescribed for each day that the offence continues.

B.??CONCLUSION

With the pervasive nature of climate-related financial risk, all financial institutions need to pay close attention to climate-related risks as part of their risk management frameworks.

CBK has taken a crucial step in steering the financial institutions towards the right direction. With the Guidance, financial institutions can now develop and implement appropriate climate-change related strategies and policies.

The time is now. The more we do to address climate change, the better it will be for the future of the planet.

?Authors: Daniel Musyoka & Karen Muthee

[1] The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the prudential regulation of banks and provides a forum for regular cooperation on banking supervisory matters