Bank watchdogs zero in on near-term climate risk

The Network for Greening the Financial System says recent extreme weather events and the war in Ukraine have made clear that the finance industry must work with short-term climate scenarios to avoid risky investments in favour of those that will help achieve net zero emission. — Bloomberg

COPENHAGEN: Banks and insurers need to anticipate the potential losses that climate change will cause not just decades ahead, but in the near future, according to the global network of central bankers and regulators created to steer the industry toward zero emissions.

The Network for Greening the Financial System (NGFS), an organisation that represents more than 100 of the world’s central banks and financial regulators, says recent extreme weather events and the war in Ukraine have made clear that the finance industry must work with short-term climate scenarios to avoid risky investments in favour of those that will help achieve net zero emission.

“It has become obvious that climate-related risks, including transition and also extreme events, can materialise,” Jean Boissinot, head of the NGFS secretariat, said in an email.

NGFS, whose long-term scenarios are already widely used to gauge financial resiliency to climate change, is now working on creating possible pathways for what could happen this decade.

Scenarios combine economic, policy and technical assumptions in different ways to illustrate the potential effects on financial and economic variables like gross domestic product and carbon prices.

NGFS’s first set of near-term scenarios, which are likely to cover three to five years, is expected in 2024.

Recent landslides, droughts, wildfires, floods and severe heat waves – as well as the war in Ukraine – are “confirmation of the need to assess the short-term financial consequences of extreme physical risks and risks related to the transition and the energy markets,” Boissinot pointed out.

The increased urgency comes as banks’ transition plans face greater scrutiny.

A May report by NGFS found they vary widely, depending on what they’re used for, as well as on clients’ transition plans.

There’s also a lack of agreement on whether national regulators can require the industry to have such plans, according to the report.

There’s evidence that the finance industry is underestimating the risks it faces from climate change.

Stress testing based on current scenarios suggests potential losses are small, but data is poor and the regulatory exercises generally fail to catch ripple effects, according to a November report by the Basel-based Financial Stability Board and NGFS.

NGFS, whose members include the US Federal Reserve, is trying to make the finance industry pay closer attention to the risks of climate change against an increasingly tense political backdrop.

In the United States, anti-ESG sentiment has continued to build over the past year, and senior Republicans have launched targeted attacks on firms perceived to be embracing environmentally or socially friendly policies.

European authorities, meanwhile, have had pushback against proposed legislation that would require transition plans, as firms complain they’re buckling under the pressure of new regulations.

Damages from climate-related events exceeded US$500bil (RM2.3 trillion) (2% of US gross domestic product) during the past 12 months, Bloomberg Intelligence estimates, a massive transfer of wealth within the US economy.

That includes damages to crops, property, construction-surge inflation, power outages and government recovery spending.

State Farm said it would no longer provide new home-insurance policies in California due to surging costs.

Filling scenario gaps is one item on NGFS’s climate agenda, which also includes understanding the implications for monetary policy.

It’s a natural extension of NGFS’s long-term scenarios, Boissinot said.

These first ones helped create a framework for understanding climate-related financial risks and will serve as baselines for short-term scenarios.

“Both contribute to making the financial sector more efficient in the transition” by limiting the risk of decisions that might later prove to be mistakes and by contributing to “better financing of the investments that support the transition,” Boissinot said. Bloomberg Philanthropies has provided grants to NGFS. — Bloomberg

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