"Environmental risk management is not corporate philanthropy," says Bray. "It is not about the bank wanting to be seen to be an eco bank. It is about understanding the extent to which environmental issues represent a risk, cost, or liability to the organization. Primarily they are environmental issues that affect the viability of the institutions to which we are lending and would inhibit their ability to repay us."

That said, the Ceres report showed that only a handful of the 40 banks studied have begun to integrate climate risks into their lending business by pricing carbon into their finance decisions. Although this would be the ideal scenario, pricing green risk has never been an exact science.

"The environmental component of the risk represented by the potential borrower is only one of many, so it is very difficult to isolate that component and then price that bit alone," says Phil Case, assistant director, sustainability and climate change, at PricewaterhouseCoopers in London. " Moreover, if something goes wrong and a bank has data that shows money has been lost as a result of environmental issues, quite often it is not the tipping point or the reason the company went down."

The dearth of accurate historical data means that climate change effects cannot be modeled, which is why it is so hard to price green risk into a loan. "There are two dimensions to risk management: one is understanding the severity of the impact; the other is the likelihood and the timescale," says Bray. "We are struggling on the latter because of the paucity of information about when the effects of climate change will become more significant."

Some banks are trying, however, with varying degrees of success. "Some have said that they price environmental risk into a loan, but that has usually been a rather blunt instrument, which is achieved by just adding half a point on to the interest rate as a blanket loading for certain sectors that are more environmentally sensitive than others," says Case. "But banks are in a competitive market and if they load half a per cent for one industry and the bank down the road does not, they will not win the business."

The addition of climate change and related environmental issues into the environmental risk pricing process will make this even more difficult, especially without accurate data, reliable modeling and scientific consensus on the effects.

UK bank Lloyds TSB has had a specific policy and process in place for calculating environmental risks across its lending portfolio since the 1990s. This was originally designed to consider the risk to the bank of cleaning up contaminated or polluted sites of insolvent creditors. More recently, however, it has been evolving, with a real focus being placed on the added risk of climate change.

"On the credit side, we are looking at our lending portfolio to prepare for changes that could potentially come into force in five, 10 or 15 years that we ought to be planning for now," says Cooper. "This is not a knee-jerk reaction that we need to get out of certain sectors altogether, but just about being aware of the potential impact environmental changes could have on certain sectors over a mid-to-long term and building that into our calculations to decide if we really want to be as heavily involved in those sectors, or would we be better placed switching the balance slightly."

Lloyds TSB's environmental risk policy classifies clients as high or low risk according to their industry sector. High-risk clients are flagged for greater due diligence by the environmental risk team into where their risks lie, and what mitigation and management systems are in place to deal with it.

"If we feel the environmental risks are not being properly managed or the risk is sufficiently high to create a concern, we would involve an environmental consultant in the process to conduct a more detailed assessment and devise a practical action plan," explains Cooper. "Environmental risk is certainly not foremost in the sales decision process; having said that, if a borrower is in a sector where there is a high environmental risk, we would expect them to be managing those risks properly. But we will always try to find a solution that allows us to lend, as opposed to introducing a hurdle which prevents that."

Barclays has a different approach. Rather than implementing a high-level environmental risk prescriptive policy, it prefers to assess every case individually. "A lot of it is to do with managing information and maintaining an awareness of what is happening in the environment arena," says Bray. "It really is a case of making sure the relevant information is available for the people who are making the business decisions. We put a lot of the responsibility for collecting information on our lending officers. Those who are chasing the business and sanctioning the lending should be aware of the potential environmental risks associated with given clients and given sectors."

Raising awareness of environmental risk and educating staff, specifically sales staff, is key for Barclays. "Educating people is an ongoing process to ensure they are aware of what environmental risks are," adds Bray. "We have backed this up internally with a series of environmental and social risk briefing notes. While some banks have specific policies on particularly emotionally environmentally sensitive sectors -- things like forestry, mining, and oil and gas -- we have guidance notes in place for something like 50 commercial activities, which are refreshed and reviewed all the time in light of new research and legislation. The next environmental risk to overlay will be to assess if any of those sectors are more at risk from climate change, the agriculture sector for example, so we can start to understand what sort of questions we should be asking clients to consider."

One example Bray gives is of a proposal to finance a hydro-electric dam that is being fed by glacial melt water. This project assumed an operating life of more than 40 years, but the engineering report did not take into account the state of the glacier in 40 years' time. "It is these sorts of questions we need to be asking now. This seems so obvious, but few are asking these basic questions as part of the due diligence process," says Bray.

It is clear that there needs to be a step change in lending practices to account for the increased risk to financial services. But only the most agile and proactive firms will reap the benefit from the changing economic environment.

Victoria Pennington is deputy editor of OpRisk & Compliance, the monthly magazine that covers regulatory initiatives and features on implementing operational risk and compliance frameworks within financial services firms.