Kenya has experienced adverse weather conditions, including droughts, floods, landslides, and forest fires. Climate change exacerbates these extreme events, leading to the death and displacement of people. For example, the Intergovernmental Panel on Climate Change (IPCC) Sixth Assessment Report warned that the impact of drought on arid and semi-arid lands (ASALs) has been acute, with over 8 million Kenyans affected by the drought in some way.
Climate risk refers to risk assessments based on a formal analysis of the consequences, likelihoods and responses to the impacts of climate change and how societal constraints shape adaptation options. In the banking industry, climate risks threaten financial system stability. For example, climate risks include loan losses and repricing of financial instruments that would seriously affect the solvency and profitability of financial institutions. Globally, central banks and financial sector authorities are increasingly interested in understanding and quantifying climate and environmental risks, using forward-looking tools such as scenario analysis and stress testing. The Central Bank of Kenya (CBK) issued guidance, benchmarked to the TCFD Framework, on climate-related risk management to the banking sector in October 2021.
The TCFD recommendations solicit decision-useful, forward-looking information included in mainstream financial filings. The recommendations include four thematic areas that represent core elements of how organisations operate.
The four thematic areas include: Governance of the organisation around climate-related risks and opportunities, their actual and potential impacts on the organisation’s businesses, strategy and financial planning, risk management as well as metrics and targets used to assess and manage relevant climate-related risks and opportunities. Additionally, the TFCD recommends that organisations describe the resilience of their strategy, considering different climate-related scenarios. By identifying and assessing the potential implications of a range of plausible future states, including a 2°C or lower scenario, where such information is material, these hypothetical constructs allow financial institutions to consider a more detailed assessment of the risks. Through climate stress testing, banks can build a further understanding of climate and environmental impacts under various historical and future scenarios.
Reporting comprehensively on climate risk remains a challenge for Kenya’s financial sector. There is a need for capacity building to improve and increase the reporting of climate-related financial information. Systematic empirical evidence from historical data has also been relatively scant. A first step would be to collect information to track such risks, including filling any data gaps that could hinder a complete understanding of climate risks. Development partners actively support CBK and financial institutions in Kenya to understand better and manage climate and environmental risks. These engagements will help the industry to better cope with these risks and transition towards more climate-proof investment and lending portfolios.
