Financial Institutions, human rights and climate risk (Shift)

Anna Triponel

March 31, 2023
Our key takeaway: Financial institutions (FIs) are steadily gaining the tools and the know-how to address and mitigate climate change impacts in their investment portfolios. But can the same be said for addressing and mitigating climate-related impacts on people? A new report from Shift highlights that banks have a critical role to play here, especially as climate change impacts intensify over time. FIs are expected to evolve beyond looking at exposure to climate change risk to proactively incorporate consideration for where climate change impacts can increase human rights risks in their investee companies, especially for already-vulnerable groups. Some key actions for FIs include adopting “outward-facing” risk management systems that assess how banks could be connected to negative human rights impacts through their investments; identifying the ways in which investing in climate-mitigation and adaptation solutions could inadvertently have negative impacts on land rights and livelihoods; focusing not only on exposure to climate transition risk but also on the physical climate risks linked to investee companies (like heat, flooding and drought causing unsafe working conditions, inadequate livelihoods and access to food and water); prioritising action and investee engagement based on the severity of human rights impacts; and considering indirect impacts on vulnerable people through risk transmission channels, as well as direct impacts through the bank’s own lending and collection practices.

Building on insights from its Financial Institutions (FI) Practitioners Circle, Shift published Climate Change and Human Rights: Avoiding Pitfalls for Financial Institutions (March 2023):

  • Adapting to climate risk but missing risks to people: traditional environmental and social risk management systems are typically “inward facing”—that is, “they are usually set up to manage reputational risks that could result in material financial consequences for the bank.” This can lead FIs to make “binary ‘go/ no-go’ decisions” on whether to finance a client based on a cost-benefit analysis for the bank, not a risk-based analysis of impacts to people. FIs incorporating the UN Guiding Principles (UNGPs), meanwhile, will adopt an “outward facing risk management approach that factors in potential impacts on peoples’ human rights to which the institution may be connected.” This is key when considering climate change-related investments designed to reduce risks to the bank, because such an approach might be in tension with human rights. For example, the report cites the example of a bank decreasing its reliance on “climate-vulnerable collateral.” That is, if a bank opts to stop providing finance in areas that are at higher risk of sea level rise or flooding, it may indirectly cause a drop in property values that leaves already vulnerable homeowners in a worse position. As another example, a bank may require high-emitting investees to put in place an energy transition plan, without also stipulating safeguards to ensure a just energy transition for workers and communities. The report highlights that banks may also “[suffer] from ‘carbon tunnel vision’”, meaning that they focus largely on climate transition risk rather than on physical climate risk, due to their own minimal physical assets. However, this approach overlooks that most businesses have both transition and physical risk—and associated human rights impacts—which an investor is therefore exposed to. Shift recommends that banks put a deliberate focus on the ways that physical risks (increased heat, water scarcity, rising sea levels, more flooding) could impact human rights, especially where their investees may be connected to resulting human rights impacts like unsafe working conditions, lack of access to water and a poor standard of living. One emerging practice for banks to incorporate this perspective, per the report, is developing climate change risk heat maps that layer risks to people over financial climate risks. 
  • Not prioritising action based on severity of impacts and vulnerable groups: The report cautions financial institutions to ensure that investees are prioritising actions to mitigate both human rights and climate risk where the risks to people are most severe, rather than those closest to their operations. While banks may see themselves as distant from the impact on the ground, “[t]en years of experience with implementing UNGPs have given rise to a body of learning on the use of leverage by banks and opportunities for building leverage, including commercial, contractual, expertise, relationship and collaborative leverage.” Where financial institutions determine that a business relationship is crucial, whether for legal or operational reasons, they do not necessarily need to divest but must be prepared to seek to mitigate negative impacts and justify their continued investment. One example is forced labour that occurs in the manufacturing of climate technology critical for reducing GHG emissions; FIs can consider “pushing portfolio companies to ensure they can trace the value chains of their products and, where problematic sources are identified, that they develop alternative sources of supply over time”; they might also seek to provide financing allowing an eventual transition away from the high-risk region. In addition, both companies and FIs might compound their risks to people by failing to identify or understand how vulnerable people might be impacted by climate change. Specifically, the report urges FIs to account for vulnerable people within risk transmission channels: “the causal chains that explain how climate risk drivers give rise to financial risks that impact banks directly or indirectly through their counterparties, the assets they hold and the economy in which they operate.” These pathways, while focused on transmission of financial risk to FIs can also cause transmission of human rights impacts through investment portfolios. For example, transmission channels can help banks identify regions with high physical climate risk, like flooding or drought, and adjust their lending and collection practices accordingly to avoid financial risk, but this tactic might put small business owners, smallholder farmers and other vulnerable borrowers at higher risk of being unable to repay their loans.
  • Overlooking FIs’ own contributions to impact: The report also highlights that banks may contribute to negative human rights impacts through their own practices, specifically lending and collection practices, in line with the example above. Another example of this in practice: a bank provides “a micro-loan to a small-holder coffee farmer who, at the time of borrowing, may have earned a steady income commensurate to the repayment obligations. If the farmer’s coffee harvest is affected by climate change, she may become unable to repay the debt.” Ultimately, the farmer is likely to become more vulnerable to human rights risks like poverty and other life- and livelihood-threatening issues. In such cases, the report recommends that, “[i]n extending retail consumer loans and measuring the capacity of borrowers to pay, banks should consider consumers may need additional financial resources to respond to climate emergencies in calculating repayment capacity,” including where climate change impacts may only become evident over longer time horizons. 

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