BIS published a book that reviews ways of addressing the climate change risks within the financial stability mandate of central banks. The book outlines policy responses, with central banks as coordinating agents in the age of climate uncertainty and examines, among other issues, challenges related to the integration of climate-related risks into prudential supervision. In this context, the book covers a discussion on how the three pillars of the Basel framework could integrate climate-related risks. The book also reviews some of the methodological challenges that financial institutions and supervisors face when conducting forward-looking, scenario-based analysis aimed at identifying, measuring, and managing climate-related risks.
The book highlights that integrating climate-related risk analysis into financial stability monitoring is particularly challenging because of the radical uncertainty associated with a physical, social, and economic phenomenon that is constantly changing and involves complex dynamics and chain reactions. Traditional backward-looking risk assessments and existing climate-economic models cannot anticipate accurately enough the form that climate-related risks will take. These include "green swan" risks: potentially extremely financially disruptive events that could be behind the next systemic financial crisis. In this context of deep uncertainty, traditional backward-looking risk assessment models that merely extrapolate historical trends prevent full appreciation of the future systemic risk posed by climate change. The book, however, highlights that scenario-based analysis is only a partial solution to apprehend the risks posed by climate change for financial stability.
Additionally, the book emphasizes that central banks have a role to play in avoiding such an outcome, including by seeking to improve their understanding of climate-related risks through the development of forward-looking scenario-based analysis. However, central banks alone cannot mitigate climate change. This complex collective action problem requires coordinating actions among many players including governments, the private sector, civil society, and the international community. Central banks can therefore have an additional role to play in helping coordinate the measures to fight climate change. Those include climate mitigation policies such as carbon pricing, the integration of sustainability into financial practices and accounting frameworks, the search for appropriate policy mixes, and the development of new financial mechanisms at the international level. All these actions will be complex to coordinate and could have significant redistributive consequences that should be adequately handled, yet they are essential to preserve long-term financial (and price) stability in the age of climate change.
Keywords: International, Banking, Climate Change Risk, ESG, Basel, Financial Stability, Scenario-Based Analysis, BIS
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