MeN recent year Regulators are beginning to warn about the threat that climate change poses to the stability of the financial system. Following the July strategic review, the European Central Bank (ECB) Create a “Climate Change Countermeasure Plan”. Mark Carney, the former governor of the Bank of England, warned about the financial risks of climate change until 2015.In the United States, the Commodity Futures Trading Commission said last year, “Climate change poses a great risk. Stability. We Financial system. “But progressive Democratic politicians have told President Joe Biden that Jerome Powell has done too little to eliminate climate risk, and he chairs the Federal Reserve Board. I’m asking you not to reappoint.
But how much damage does climate risk bring? Early stress testing and corporate disclosure by central banks is beginning to shed light on this issue. In most cases, the evidence that it can bring down the financial system is overwhelming. However, there are many questions about whether the government will provide a clear path to reduce emissions, such as through carbon taxes and energy efficiency standards, and give banks enough time to prepare.
Climate change can affect the financial system in three ways. The first is what regulators describe as “transition risk.” These are most likely to occur if the government pursues stricter climate policies. If so, the economy will be restructured: capital will move from the dirty sector to the cleaner sector. Companies in the polluted industry may default on loans and bonds. Their stock price may collapse.
The second channel is financial companies’ exposure to the dangers of rising temperatures. Although it is difficult to attribute individual natural disasters to climate change, the Financial Stability Board, a group of regulators, said that global economic losses from weather-related catastrophes began at $ 214 billion in the 1980s. Prices in the 2019s are estimated to have reached $ 1.62 billion in the 2010s. , Approximately 3 times as global market share GDP.. These losses are often borne by the insurer (although over time the costs should be passed on to the customer through higher premiums).
The financial system can also be exposed to a wider range of economic damage caused by climate change, such as when it causes fluctuations in asset prices. This third channel is difficult to quantify. Academic estimates of the effects of warming at 3 ° C (compared to pre-industrial temperatures) deviate from the global economic loss of about 2% to 25%. GDPA group of supervisors, according to the network for greening the financial system. If climate change causes conflict and large-scale migration, even the most pessimistic estimates can turn out to be too rosy.
Perhaps the worst-case scenario for the financial system is when the transition risk crystallizes very suddenly, causing more widespread economic damage. In 2015, Kearney said, named after economist Hyman Minsky, could sharply adjust investor expectations for future climate policies, leading to asset fire sales and widespread price revisions of risk. I explained “Minsky Moment”. It can spill over to higher borrowing costs.
The value of financial assets exposed to transition risk is potentially very high. According to the climate think tank Carbon Tracker, about $ 18 trillion in global equities, $ 8 trillion in bonds and $ 30 trillion in unlisted debt are associated with the high-emission sector of the economy. This is compared to the $ 1 trillion market for collateralized debt obligations (CDOs) In 2007, this was the center of the global financial crisis. However, the impact of the loss depends on the owner of the asset. For example, regulators may be particularly concerned about the exposure of large “systemically important” banks and insurance companies.
Preliminary stress tests conducted by central banks suggest that climate change may be able to manage the impact of these types of financial institutions. Bank of France in AprilNSNSNS) Announced the results of such exercises. We found that French banks have low exposure to migration risk. However, in some areas, claims against insurance companies have increased more than five-fold as a result of worsening droughts and floods.
In a recent treatise ECB And the European Systemic Risk Board found similar results. Eurozone banks and insurers had “limited” exposure to the highest-emission sectors, but lost in the “hothouse world” scenario, where temperatures rose 3.5 ° C compared to pre-industrial levels. Was more serious. Nevertheless, in both cases, the loss of corporate loans of banks was only about half the level of regular stress tests of eurozone lenders and was considered to have sufficient capital to pass. rice field.
These findings are consistent with exercises by the Central Bank of the Netherlands (DNB) In 2018, the impact of transition risk on Dutch financial companies was found to be “manageable”. In the most serious scenario, the rapid development of renewable energy was accompanied by a sudden change in climate policy, causing a “double shock” and a serious recession for businesses. Still, banks’ capital adequacy ratios fell by about 4 percentage points. This is quite large, but still less than what banks have experienced in this year’s regular stress tests by the European Banking Authority.
How realistic are these stress tests? Carbon Tracker’s Mark Campanale is skeptical and points out that most companies are using older models. He argues that if auditors emphasize corporate assets against much lower oil prices, the associated write-downs can cause the kind of investor sentiment disruption that regulators fear. increase. Also, the stress test does not include a full-fledged Minsky crisis.
But in other respects, they are conservative. Most tests used an accelerated time frame. DNB When NSNSNS Case — In effect, suppose the company is sticking to its current balance sheet. However, it seems reasonable to assume that banks and insurers will change their business models as climate change progresses, reducing their impact on the financial system. NS NSNSNS For over 30 years, companies have performed a second exercise that has allowed them to make realistic changes to their business models. Not surprisingly, this allowed banks to significantly reduce lending to the fossil fuel sector and insurers to raise premiums.
Nonetheless, stress testing reveals the importance of giving companies time to adapt. And it makes the predictable path of government policy important. NS NSNSNS We found that credit losses were highest when policies were delayed and there was a sudden transition. Perhaps the most plausible scenario in which climate change affects financial stability is one in which the government has no choice but to take drastic action in the future. ■■
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This article was published in the printed version of the Treasury and Economy section under the heading “Hot Take”.
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