1.    Introduction

The only way to avoid the adverse effects of climate change is by limiting global warming to well below 2°C and pursuing efforts to limit it to 1.5°C[1]. We have all experienced effects of climate change somehow- the globe is getting warmer with resultant frequent droughts and associated famine, heatwaves, wildfires, flash floods etc. To address the climate change concerns, in December, 2015, 196 states adopted the Paris Agreement (the Agreement). This is a legally binding international treaty on climate change which came into force in November 2016. The goal of the Agreement is to reduce greenhouse gas emissions and accelerate the transition to a lower-carbon economy to keep global temperatures below 2° Celsius. The Agreement works on a 5-year cycle. Therefore, 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.

2.   Local action and financial institutions

Previously, financial institutions did not get involved in climate change debates and actions. 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.

The 2021 Basel Committee’s[2] Report on climate related risk factors and transition channels suggests that financial institutions are exposed to climate change through macro- and microeconomic transmission channels that arise from two 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.

3.   Central Bank of Kenya Guidance on Climate-Related Risk Management

In tandem with the commitments made under the Agreement and in recognition of the challenges and opportunities posed by climate change, the Central Bank of Kenya (CBK) developed Guidance on Climate-Related Risk Management (the Guidance) for financial institutions in October, 2021. The Guidance was issued in pursuant to section 33 (4) (b) of the Banking Act, (CAP 488) which gives CBK the power to guide institutions maintain a stable and efficient banking and financial system.

Purpose of the Guidance

The Guidance requires banks to integrate climate related risks into their governance, strategy and risk management frameworks as well as disclose financial risks posed by climate change.

Scope of the Guidance

The guidance is aimed at:

i.         Guiding financial institutions manage climate related risks by integrating climate related risk management into their business decisions and activities,

ii.         Providing financial institutions with a roadmap to integrate climate related risks in their decision making frameworks.

iii.         Setting out requirements that institutions should consider adopting to effectively entrench climate-related financial risks in their risk management frameworks.

Specific requirements for financial institutions

The Guidance requires all financial institutions to have an effective governance structure to 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 respective institution’s exposure and responses to climate related issues and ensuring that 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.

Timelines for implementation of the Guidance

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.

4.   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.

[1] The Paris Agreement on climate change
[2] 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.

Authors:

Daniel Musyoka, Partner (Litigation)

Karen Muthee, Associate (Litigation)