A senior member of the Bank of England’s Financial Policy Committee (FPC) has warned the size and scale of the systemic risks posed by climate change will require a concerted and global strategy to ensure the stability of the financial sector.
Speaking at Queen’s University in Belfast, Elisabeth Stheeman (pic) an external member of the FPC and an external member of the Bank of England’s FMI (Financial Market Infrastructure) Board, said while climate change has been on the committee’s agenda for many years the threat is now a systemic one to the financial system.
“The financial risks from climate change can be seen through two main channels – physical risks and transition risks,” she explained.
“Physical risks can arise from damage to property, land and other infrastructure as well as disruption to business supply chains and food systems. This could affect the safety and soundness of financial institutions that the Bank of England supervises, for example by reducing asset values or resulting in lower profitability for companies, and through insurance losses, or losses on mortgages.”
“Transition risks stem from the move towards a net zero economy, arising from changes in climate policy, technology and shifting consumer preferences,” explained Stheeman. “This could prompt a reassessment of the value of a large range of carbon-intensive assets and lead to higher costs of doing business as a result. This impacts energy companies but also transportation, infrastructure, agriculture, and real estate to name just a few. The implied change in energy costs has already been having a significant effect on many businesses, even before the recent sharp rise in global energy prices following Russia’s invasion of Ukraine. In turn, this could give rise to credit risk for lenders and market risk for insurers and investors.
“Climate-related risks could destabilise capital markets and have the potential to cause disruption across the broader economy.”
She warned a failure to “price climate risks sufficiently could lead to significant financial losses”.
“There is now widespread agreement amongst global policymakers and industry that climate change poses increasing and material financial risks,” said Stheeman. “These risks cannot be addressed or mitigated by individual institutions alone, and that includes central banks. Ultimately, these risks are mitigated by reducing greenhouse gas emissions across the economy. The main responsibility for driving that outcome lies with governments, rather than central banks, through setting climate policy.”
She added responsibility for achieving net zero also lies with industry through innovation and climate action, with private finance through facilitating investment to support those changes, and with consumers through the spending and personal investment choices they make.
“But this is hard, as actions need to be taken against a background of emerging policies, and an ever-changing external environment. For example, the impact on the transition to net zero of the increase in energy prices, as a result of Russia’s unjustified and illegal invasion of Ukraine, is yet to be determined. The increased demand for coal which we have seen is not consistent with a steady path to net zero.”
Stheeman added: “It is clear therefore, that the financial system also has an important role to play in supporting an economy-wide and orderly transition to net zero. As some of these financial risks could pose a systemic risk, they are in the domain of the FPC.
“The FPC is particularly well-placed to help deal with risks to the financial system arising from climate change and the net zero transition. Climate-related financial risks have similar features to other financial stability risks, which reflect the distinct challenges associated with financial stability policymaking, and in which the FPC has a comparative advantage.
“As I have mentioned, climate-related financial risks are systemic, with their impact likely to be correlated and therefore felt widely. They are also non-linear, meaning that they don’t unfold in a smooth or straightforward manner. Another feature is that climate-related risks are foreseeable, and they are also uncertain, in that we don’t know when they will emerge.”
Stheeman concluded: “The work the Bank of England and the FPC in particular are doing will contribute to progress towards assessing and mitigating the financial risks from climate change. In cooperation with other policymakers, we will continue to play our part in tackling climate-related financial risks. Climate change is an unprecedented challenge, which will demand an equally unprecedented degree of international cooperation today, tomorrow and in the future.”