REGULATION

Lenders must now factor in climate-based risks - CBK

Climate change poses a huge credit , operational, liquidity and reputational damages to lenders

In Summary
  • It provides institutions with a roadmap to integrate climate-related risks in their decision-making frameworks. 
  • Kenya's temperature to rise 2.5ºC by 2050
A general view shows people walking past the Central Bank of Kenya headquarters building along Haile Selassie avenue in Nairobi, on October 9, 2017. /REUTERS
A general view shows people walking past the Central Bank of Kenya headquarters building along Haile Selassie avenue in Nairobi, on October 9, 2017. /REUTERS

The growing concern about climate change has forced the Central Bank of Kenya to push lenders to institute measures to avert resultant financial loss.

According to the recently published Guidance Note on Climate-related Risk Management, banks will from June next year have to factor climate change component in their lending mechanism. 

This will for instance see a loan application by a maize farmer in Kitale undergo extra scrutiny, with lenders factoring in a possible drop in rainfall, locusts invasion, or any climate-based risk.

Banking sector analyst Boaz Nyamweya says the guidance will either be a positive or a negative to borrowers as some aspects compel lenders to share or cushion their customers from adverse effects of climate change.

''Climate change risk aspect on loans could trigger hesitation among lenders or an increase in interest at worst. Banks could also use this to boost their climate change-sensitive profiles. It is two ways,''Nyamweya told the Star on phone.

Under the new guidelines commercial banks and mortgage finance institutions will have to brief CBK on any financial risks arising from climate change. They have up to  June 2022 to comply.

"This guidance sets out some basic requirements that institutions should consider adopting to effectively entrench climate-related financial risks in their risk management frameworks,'' the CBK report reads.  

The guide aims at guiding financial institutions to manage their climate-related risks by integrating climate-related risk management into their business decisions and activities.

CBK wants the board of directors and senior management of an institution to formulate and implement climate-related financial risk management strategies, policies, procedures, guidelines and set minimum standards for an institution.

Boards have been tasked with the responsibility of assessing and quantifying the institution’s exposure to climate-related risks arising from its various lines of business.

Senior management will oversee the implementation of the institution’s climate risk strategy through regular updates and management information.

The regulator has asked lenders to develop and submit to a time-bound plan approved by the institution’s Board on how they plan to implement the guidance herein, which is approved by the Board by June 30, 2022.

The plan is to be signed by both the chairman and chief executive officer of the institution.

Subsequently, each institution shall submit a quarterly report to CBK on the progress of its implementation of the Plan within 10 days after the end of every calendar quarter from the quarter ending September 30, 2022.

According to CBK, climate change poses a huge credit risk as it can reduce the collateral value, borrowers’ repayment ability, or institutions’ recovery of the loan outstanding in the event of default.

It adds that large, sudden and negative price adjustments may be triggered when climate risk which has not yet been incorporated into prices or valuation, is materialised.

It also carries a liquidity risk where access to funding sources could be reduced as market conditions as climate risk drivers may cause counter-parties of institutions to withdraw deposits and draw down credit lines.

According to World Bank, Kenya is vulnerable to climate change with current projections suggesting that its temperature will rise up to 2.5ºC between 2000 and 2050, while rainfall will become more intense and less predictable.

Even the slightest increase in the frequency of droughts will present major challenges for food security and water availability, especially in Kenya’s Arid and Semi-Arid Lands (ASALs) in the north and east 

Other parts of the country, most notably in the Rift Valley region, are also vulnerable due to increasing extreme events while glacier melt will further reduce future water availability.

Coastal areas are likely to suffer from rising sea levels and associated floods and saltwater intrusion.