What risks does climate change pose to the stability of financial institutions? What role can and should supervisors play in mitigating these risks? These increasingly pressing questions were topics of discussion in Amsterdam on Friday, where 200 central bankers and financial supervisors from over 30 countries gathered during the first ever International Climate Risk Conference.
Although the world came to agree that global warming should be kept under 2°C in the Paris Accord, entailing deep decarbonization of the global economy in the decades to come, the market capitalization of the largest greenhouse gas emitting industries do not seem to reflect these prospects. Despite 60 to 80 percent of global coal, oil, and gas reserves having been labeled unburnable without breaching Paris Agreement emission reduction targets, companies keep investing in expanding capacity. Figures estimated for the year 2012 by the London School of Economics and Political Science Grantham Research Institute on Climate Change and the Environment suggest that $674 billion was invested in what would potentially be completely stranded assets, adding up to $6 trillion in the next 10 years.
Current stock prices of carbon intensive industries are thus based on future profits that will never materialize if the energy transition is to advance at the speed required to meet the Paris Agreement. Such big names in the financial sector as Mark Carney, governor of the Bank of England, have already put out warning about what they consider a “carbon-bubble.”
It has to be noted that analysts have pointed out that most of the market capitalization of these companies is based on expected profits over the next 15 years, as cash flows farther into the future are heavily discounted. In the slightly longer run, however, severe drops in profitability of carbon intensive industries (thus ultimately evaporating market value) are not unthinkable. If suddenly whole branches, from oil refinement to air travel and synthetic fertilizer production, cease to make sense economically — as carbon prices drastically increase — a shockwave will profoundly shake the entire financial system, potentially triggering another 2008-sized economic crisis. Reason enough for those responsible for the stability of the financial system, central bankers and other regulators, to convene on how large these climate-related risks are, and how they can be contained.
The International Climate Risk Conference was initiated by the Dutch Central Bank DNB, Banque de France/ACPR, and the Bank of England — underneath the recently established Central Banks and Supervisor Network for Greening the Financial System (NGFS). Launched at the Paris One Planet Summit in 2017, this network aims to “strengthen the global response required to meet the goals of the Paris agreement and the Sustainable Development Goals,” both by enhancing the role the financial system plays in controlling climate risks as well as by mobilizing capital for low-carbon investment. The level of participating institutions, from the People’s Bank of China to the Deutsche Bundesbank, signal that climate related risks are on the agenda of financial regulators globally, potentially speeding up the reallocation of capital from carbon-intensive to more sustainable sectors.