How fintechs like Aquaoso help banks assess climate risks in their lending portfolios

New innovations in fintech are bridging the gap between financial institutions and understanding climate risks in loan portfolios. Lenders can leverage software services to uncover climate-related risks, comply with a changing regulatory environment, and begin implementing more sustainable investment strategies.

Regulators have been stressing that the tools the financial system currently has at hand are insufficient for proper climate-related risk assessment. Investors, regulators and market participants need better data, including enhanced and transparent disclosures to create an accurate picture of financial risks posed by the changing climate. 

This gap in the market is being addressed by climate-focused fintechs that aim to help financial institutions with assessing their loan portfolios’ climate-related risks. 

One such company is Aquaoso, a software as a service cloud-based platform, which uses data science and machine learning to help financial institutions make informed decisions on their loan portfolio from a climate perspective. 

The fintech has developed tools for lenders to fill out due diligence components of climate risks related to loans. It uses a scoring system, such as a water security score for example, which ranks the risk of a particular operation from a water standpoint.

Lenders can also analyze their portfolios as a whole by bringing in bank data into Aquaoso’s platform, such as loan data, appraisal data, customer data, sales, valuations, etc. The fintech then layers various climatic events to allow its customers to pinpoint where they're most at-risk within their loan portfolio. 

“That's incredibly powerful from a risk decisioning model, helping them understand what types of risks exist inside of their loan portfolio. But it also allows them to have better conversations with their customers and better connections with their borrowers,” Aquaoso CEO Chris Peacock told Tearsheet.

Lenders can also use this capability to undergo stress testing inside of their portfolio and do scenario analysis, which can then be used to report up from a regulatory standpoint. This feature is becoming increasingly meaningful as government watchdogs have been stressing the importance of such exercises for financial institutions, and regulations in this area are expected to change under the current administration. 

Cervest is another company that developed an open and AI-powered climate intelligence platform for businesses, investors, and financial regulators. Its first product, Earthscan, enables companies to calculate the combined climate events (floods, fires, extreme heat, etc.) to their specific global assets and disclose that financial risk accurately.

Another product the firm is developing is EarthCap, which embeds climate intelligence in transaction-level decisions to build a personalized asset portfolio, as well as find opportunities or vulnerabilities within that portfolio.

“Banks, asset managers and insurance providers will be able to use the climate risk capabilities of EarthCap to integrate cutting-edge climate modelling research into risk and investment decisions,” said Partha Bose, head of capital markets at Cervest. 

“Fundamentally, the industry needs support to reprice risk, optimize allocation of funds, and introduce innovative financial instruments that incentivize a climate positive industry,” he added.

Cervest raised $30 million earlier this year from notable business and climate leaders such as Salesforce's Marc Benioff and Lowercarbon Capital's Chris Sacca. 

Data is another big problem when it comes to assessing climate-related risks. The Financial Stability Oversight Council highlighted in its most recent report that there is a huge gap in this area as current research is limited, and proper data is key to understanding the risks faced by banks and the financial market as a whole. 

But expecting banks or other financial institutions to develop such data capabilities on their own isn’t realistic or scalable, according to Aquaoso’s Peacock. Historically, climate data has been fragmented, and the technology has evolved significantly over the last few years, making it cost-prohibitive for a company to do it in-house. In his opinion, this is why banks have been struggling to understand the climatic impacts in their loan portfolios. 

“It's expensive for a bank to go build all of that technology stack and then maintain it. The majority of banks can't afford to build a platform like this. They've relied on their internal team and large consulting firms that would do large studies, but those studies become stale over time and can't be used across an entire portfolio of loans,” Peacock added. 

At Aquaoso, the focus was water-centric at first, developing its platform by essentially scraping water data together from various sources, building its datasets from the ground up, and incorporating more weather and climate aspects into its platform over time. 

This ground-up approach is a big challenge around climate data, Peacock argues, as most information exists at a macro level, which doesn’t necessarily showcase a risk’s real-world implications. This is why he aims to bring together both the macro and the micro sources of data into a single platform that allows for more holistic analysis.

“I think in the long run, climate analytics is going to be commoditized and become easier to use as folks like Google, Amazon and Microsoft, and all of the other big players in the space make that data more available as a public good. But then the challenge becomes how to use that data,” he said. 

The technology advancements of the past few years, such as artificial intelligence, blockchain and machine learning, have also been helping to fill in the gaps of the data where it didn't necessarily exist before. Now companies like Aquaoso can leverage this technology to geospatially map specific loans to specific climate risks, and then surface what's going on across those loans, Peacock said.

The end goal is to help financial institutions understand how things are going to change, and how to weather the change from an economic standpoint. A key aspect is understanding that historical returns failed to account for environmental impacts, and these mounting consequences can’t be avoided much longer. 

“There are returns on investment that have to be made from a business standpoint to keep certain operations in place, but those operations can’t stay in place if there's huge environmental damages associated with it. If it’s not sustainable environmentally, that becomes unsustainable economically as well,” he said. 

While climate change is altering the status quo, it is also opening up lots of possibilities for lenders, especially if they’re looking to have a positive impact. The market for sustainability-linked lending products is growing exponentially, surging from $5 billion in 2017 to $120 billion in 2020, according to S&P Global data. 

“We're in business to both make money and an impact in the world. We see major opportunities, and we don't see any conflict with doing good. In the long run, we believe all of those things are very much working in harmony together,” Peacock concluded.