On 23 November 2020, the Financial Stability Board (FSB) published a report that discusses the potential implications of climate change for financial stability. It investigates channels through which climate-related risks might impact the financial system.
- Sets out the ways in which physical and transition risks from climate change can affect financial stability, as well as the potential for these to interact.
- Examines how climate-related risks might be transmitted across, and amplified by, the financial system including via its interaction with the real economy.
- Examines the degree to which climate-related risks might be transmitted across borders, including through the exposures of financial institutions.
- Examines actions by market participants and regulators that might go some way towards mitigating climate-related risks to financial stability.
- Sets out some proposed next steps for the FSB’s work in this area.
The report does not discuss the possible implications of climate change for the broader macro economy or the functions and responsibilities of financial authorities beyond those relating to financial stability. This includes those functions relating to monetary policy, securities regulation and portfolio management.
Key points in the report include:
- At a high level, risks to financial stability from climate change are typically divided into: (i) physical risks, that is, the possibility that the economic costs of the increasing severity and frequency of climate-change related extreme weather events, as well as more gradual changes in climate, might erode the value of financial assets, and/or increase liabilities; and (ii) transition risks that relate to the process of adjustment towards a low-carbon economy. Whilst such an adjustment may be a necessary part of the global economy’s response to climate change, shifts in policies designed to mitigate and adapt to climate change could affect the value of financial assets and liabilities.
- The magnitude of physical and transition risks and the relationship between them is likely to depend not only on the course of climate change, but also the course of action to mitigate it.
- Physical and transition risks might also interact and crystallise in tandem.
- Absent action to reduce the effects of climate change, physical risks to the global economy are likely to continue to increase in future.
- Increased physical risks could result in both market and credit risks to the financial system.
- Estimates of the impact of physical risks on financial assets vary considerably.
- An acceleration in the progression of climate change, and in the manifestation of physical risks, could have a destabilising effect on the financial system.
- Financial institutions may also be exposed to operational risks as a result of climate change. Extreme weather events could disrupt firms’ operations, and affect other firms (financial and non-financial) to whom they provide financial services. This also may amplify risks to financial stability.
- A disorderly transition to a low-carbon economy, unanticipated by market participants, could have a destabilising effect on the financial system.
- The cross-border transmission of climate-related risks via financial institutions could serve both to amplify – and to mitigate – risks to financial stability. On the one hand, it could give rise to diversification, by transferring risks to those best placed to bear them globally. On the other hand, cross-border exposures can also amplify risks. Cross-border lending might lead to risks affecting one country being concentrated in another jurisdiction. To the extent that such jurisdictions, and the financial systems within them, are not resilient to such risks, this might create financial stability risks.
The FSB will conduct further work to assess the availability of data through which climate-related risks to financial stability could be monitored, as well as any data gaps. This further work will be completed by October 2021.