Shipping banks remain exposed to latent systemic refinancing risks as a result of the energy transition and tightening shipping emission regulations, UCL study finds

LONDON: A new report from the UCL Energy Institute and Strider Carbon finds that while banks seem largely insulated from direct losses when climate transition risks strand individual vessels, industry-wide behaviour may be converting transaction-level credit risk into a deferred, systemic refinancing problem as a result of the energy transition and tightening shipping emission regulations. The report, “Exploring the Financial Impacts of Transition-Related Stranded Asset Risks,” examines how climate-driven devaluations, for example arising because a ship is unable to cost-effectively comply with GHG regulations, can cascade through the most common ship financing structures. The report maps the resulting exposures onto standard banking risk categories and evaluates the mitigation strategies currently being deployed by European financing institutions.

Prasanna Colluru, Managing Director at Strider Carbon, said: “Tracing how transition risks map onto traditional credit risk categories gives banks a supporting lens for assessing their ship finance portfolios and strengthening their climate risk management strategies. This analysis shows where existing debt structures are resilient, and where the architecture of those structures may be creating vulnerabilities that aren’t yet visible at portfolio level.”

In the absence of systemic shocks, banks appear to be largely protected from direct losses if climate transition risks materialise, both under supply-side risk, arising when vessels become economically unviable due to tightening emissions regulations, and demand-side risk, arising when the global energy transition erodes cargo volumes for fossil fuel carriers. Liquidation scenarios illustrated in the study, across three common financing mechanisms — bilateral loans, ECA-backed facilities, and syndicated structures, demonstrate that, at the conservative loan-to-value (LTV) ratios typical of European ship finance (40–60%), substantial asset devaluation, beyond that associated with conventional shipping cycles, is required before banks face direct losses. In all three structures, equity held by shipowners absorbs initial losses, with senior debt repaid in priority.

However, the report warns of systemic refinancing risks as an emerging concern. The mismatch between typical loan tenors of 5–7 years and vessel operational lifespans of 20–25 years enables individual banks to cycle out of transition-exposed positions before end-of-life devaluations materialise. The report therefore identifies a collective action problem: if transition concerns cause multiple institutions to simultaneously restrict lending in the mid-to-late 2030s, the resulting fire-sale conditions could compress recovery values below outstanding loan balances, generating direct losses for the banking system as a whole despite individual banks’ attempts to manage their own exposure.

The report identifies several constraints limiting the effectiveness of banks’ climate risk management in shipping: the fundamental misalignment between loan and asset lifetimes; fragmented and non-comparable borrower disclosure data; competing taxonomy definitions that create regulatory arbitrage and a potential false sense of compliance; the complexity of modelling non-linear, multi-variable climate scenarios within existing credit risk frameworks; and resource constraints that make shipping-specific analytical capability difficult to develop within institutions for which the sector represents a modest share of the overall portfolio.

Dr Nishatabbas Rehmatulla, Principal Research Fellow and Co-Director of the Shipping and Oceans Research Group said: “Climate risk modelling in shipping is complex, requiring integration of multiple variables like regulations, technology specifications and fuel price scenarios, often long-term and non-linear trends, which existing methods might not be able to capture. In the absence of rigorous, transparent and shared frameworks to capture climate resilience, banks and other financiers may be implicitly factoring these considerations into valuations in unsystematic ways which risks creating blind spots that only become visible under stress, as shown in this report”.

Previous work by the Shipping and Oceans Research Group has shown that gas tankers and oil tankers, the segments most exposed to demand-side stranding risk, carry substantial bank debt exposure with France and South Korea heavily investing through bank loans. Among identified financing transactions, loans accounted for over half of the share of finance identified for LNG carriers (USD 21 billion), and approximately 40% of USD 35 billion for oil tankers.

The study also conducted a systematic review of publicly disclosed bank strategies and identified 20 mitigation actions currently being developed or implemented by European ship finance institutions to address supply-side and demand-side risks and finds that there is an imbalance between banks strategies. The majority of the strategies are around supply-side risks — fleet efficiency, regulatory compliance, and technology transition — while only a small minority of actions specifically addresses demand-side cargo volume shifts arising from fossil fuel displacement. The report suggests this imbalance may reflect banks’ greater capacity to model vessel-level regulatory risk than to translate macroeconomic energy transition scenarios into transaction-level credit assessments.

The report recommends that industry coalitions such as the Poseidon Principles extend their frameworks to encompass demand-side scenario analysis, to capture the full extent of climate risks posed to financiers. Public and grant finance should be used to de-risk supply side transition risks to the point of bankability, including through mechanisms funded by EU ETS revenues and the revenues generated from any IMO Net Zero Fund as part of the Net Zero Framework as agreed in April last year. This also highlights the role any IMO Fund could play in supporting a managed transition, without which, supply-side transition risks may be harder to mitigate in an orderly way, with potential knock-on effects for the shipping finance system.

Link to full report: https://www.shippingandoceans.com/post/shipping-banks-remain-exposed-to-latent-systemic-refinancing-risks