Luiz da Silva of BIS on Role of Central Banks to Address Climate Risks

Mr. Silva highlighted that reports from the insurance industry show a growing level of insured and uninsured losses resulting from climate-related risks. These losses impact the financial health of the insurer and the equity value of firms that are subject to these weather-related events. According to him, climate change can impact financial stability through three types of risks: physical risks, transition risks, and liability risks. He added that risks and returns of financial assets can become new key determinants of how effectively climate change can be combated. If investors assess and price financial risks properly, then polluting assets will become more costly. In turn, more investments will flow into green assets, driving the transition to a low-carbon economy. Research conducted at the BIS is looking into the potential mispricing of climate change-related risks. The research also examines if climate change risks, especially those related to climate policy risks, are priced into the bank syndicated loan market by combining syndicated loan data with environmental exposure data. It shows that insurance companies are reassessing their cost of insuring physical risk; rating agencies are repricing climate-related risks and reassessing the quality of credits; asset managers are becoming increasingly selective and inclined to start picking "green assets" for their portfolios; and pension funds are beginning to reassess their exposure to climate-related risks and "brown assets."

According to him, the central banks need to be concerned about climate-related risks because of their financial stability implications. Central banks should clearly identify and quantify the risks to the common pool resource, that is, financial stability and find actions that reduce climate-related risks at the global level and also at a decentralized (local) level. They should monitor these arrangements and design and enforce rules for system stability, which implies coordination, local participation, and a sense of fairness in burden-sharing, incentives, and penalties. He added that, although the market for "greener" financial investment instruments has boomed, more progress in the taxonomy of what is "green" is necessary to avoid "green-washing" and excessive free-riding on the green label.

Assessing the costs and benefits of more regulatory, direct interventions is also important. In addition to progress on disclosure of climate-related risks, some regulators and supervisors are also exploring the pros and cons of more interventionist approaches—namely, "green" relending facilities using adequate collateral, a subsidized administrative credit policy favoring "green" projects, and even ad hoc macro-prudential measures. The obvious issue here is to assess whether this proactive approach could create other distortions that could hamper the greening of the financial system and delay some of the initiatives described above. He concluded that central banks and supervisors cannot take on these new climate change risk-related challenges alone; they will need support from other policies conducted by other actors.

Related Link: Speech

Keywords: International, Banking, Green Finance, Sustainable Finance, NGFS, Climate Change Risks, ESG