Banks should recognise the risks of climate change
19 December 2018 | Mitigation
Most central bankers make a virtue of the narrowness of their remit, remaining circumspect on issues deemed to go beyond it. Not Mark Carney, governor of the Bank of England, who, despite facing criticism for exceeding his mandate, has suggested the risks arising from climate change should form part of its annual stress tests for banks from 2019.
The suggestion is timely. It comes a few days after rules governing how to implement the Paris climate agreement were approved, against significant odds, by nearly 200 countries at the COP24 talks in Poland. It is also uncontroversial — it does not require a change to the regulatory framework, but simply adds a risk to the list that banks are already meant to measure.
Furthermore, the Bank of England is suggesting including climate change as an exploratory scenario, which banks can neither pass nor fail. They are required only to scrutinise whether they are doing enough.
For that reason, many climate activists will consider the proposal, much like the Paris agreement itself, does not go far enough. The measure should at least help to convince financial sector actors of the potential impact they face from climate issues.
The latest warnings about global warming are sobering. The recent Intergovernmental Panel on Climate Change report noted that on current trends, average global temperatures are set to rise by 3-4C from pre-industrial levels by 2100. Failure to take action to curb that rise creates multiple risks.
Extreme heat events are likely to multiply. So, too, are the frequency and intensity of heavy rain and floods, and of droughts. Actions taken to mitigate climate change also carry risk.
New policies aimed at limiting average global temperature rises, in line with the Paris agreement, will make it harder for hydrocarbon-intensive industries to operate profitably. This could leave companies with stranded assets worth billions, and the banks that lent to them with enormous unpaid debts.
Whatever the source of the risk, a core function of a central bank is to ensure that money is being safely lent. Lenders are moving slowly because unlike the insurance sector they are less directly exposed to the destructive power of extreme weather. But they are not immune — and should be paying more heed.
The consequences for the whole financial system would then be catastrophic. Any move by the Bank of England to incorporate climate risks in stress tests would be the first by a central bank of a major financial centre. But others are alert to climate change risks.
In 2017, the Dutch central bank published a report entitled “Waterproof?”, which concluded that financial institutions should factor in the consequences of a changing climate and the transition to a carbon-neutral economy. Such steps alone will not prevent the oceans rising, climate-induced mass migration or extreme weather.
Governments must develop policies and regulatory environments that change businesses’ behaviour. The “tragedy of the horizon”, as Mr Carney puts it, is the danger that by the time climate change is recognised by enough actors to be a defining issue for financial stability, it may already be too late to manage it.
Source: Financial Times