The physical manifestations of a changing climate are visible across the globe, as are their socioeconomic impacts. Governments and organizations around the world increasingly recognize that the physical risks associated with a changing climate will continue to build up until net-zero emissions are achieved.
However, decarbonizing the global economy to reach net-zero will require significant economic transformation. In fact, research indicates $9.2 trillion in annual average spending on physical assets through 2050 may be needed, with 70 percent of this going towards low-emissions products and enabling infrastructure, such as wind and solar generation.
Achieving this aggressive target requires urgent and decisive action, and banks as well as other financial institutions can play a pivotal role in the large-scale capital reallocation likely needed to reach net zero—in addition to managing their own risks and opportunities.
To support banks on navigating these issues, McKinsey Sustainability and Moody’s Analytics have joined forces. The collaboration brings together complementary strengths of both companies, including Moody’s deep analytical capabilities, particularly in modeling the physical risks of climate change and translating them into credit risk impact, and McKinsey Sustainability’s extensive expertise in modeling transition risk and advising banks on integrating climate risk into business processes, and reducing financed emissions.
Cindy Levy, a senior partner with McKinsey Sustainability, says, “We are thrilled to be collaborating with Moody’s Analytics to strengthen banks’ resiliency to the present and future risks from climate change, and to align their portfolios to net-zero pathways.”
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McKinsey Sustainability and Moody’s will work together to help clients effectively manage climate risk. This includes physical risk: using catastrophe-based models to simulate the impact of physical hazards; transition risk: using models that forecast the impact of the transition to a low-carbon economy; and credit risk: translating the financial impact of physical and transition risk into the credit profile of borrowers, loans, and assets using robust credit models across all major asset classes.
For one U.S. bank, McKinsey Sustainability and Moody’s have helped measure the credit impact of physical and transition risks on their Commercial Real Estate and Residential Real Estate portfolios under different climate scenarios, which has enabled the bank to take more informed decisions in credit portfolio management. For example, they are re-examining their approach to borrower and transaction-level risk assessments to better factor in the impact of climate risk on the credit profile.
The collaboration will enable banks to model climate exposure at a number of different levels across sectors and regions, and help them to quantify— at a granular level and in financial terms—climate risk across their portfolios.
“Banks are looking for better tools to integrate climate risk into their decision-making, whether they are looking at credit assessment, stress testing and scenario analysis, or regulatory needs,” said Jacob Grotta, General Manager, Banking Solutions at Moody’s Analytics. “By working with McKinsey Sustainability, we are able to provide broader, comprehensive solutions to clients – helping them understand what needs to be done with advisory and consulting and how to do it with the tools, data, and analytics Moody’s is known for.”
The collaboration builds on the efforts of both McKinsey Sustainability’s Planetrics solution, which helps financial institutions assess climate risk and opportunity, and the Moody’s Analytics suite of climate solutions.