Climate Change and Financial Stability
The impact of climate change on the global economy is already well known to investors. The World Economic Forum also listed climate change as an important risk factor in its global risk report. How does climate change affect financial stability, and how should the financial industry address these risks?
This article reviews the speeches of former Bank of England Governor and Chairman of the Global Financial Stability Board, Mark Carney, at a meeting of the global insurance company Lloyd, in order to analyze climate change and financial stability. This speech also attracts the attention of regulatory agencies to climate change.
Tragedy of the Commons and Tragedy of Horizon
A classic problem in environmental economics is the tragedy of the commons. When herders can graze on land that is not their own, they will raise a large number of sheep without considering the capacity of the land. In the end, the land was abandoned and the sheep lost their foods.
The tragedy of the commons is directly related to property rights, and current climate change can also be regarded as the tragedy of the horizon. The impact of climate change on the environment is well known globally, such as greenhouse gas concentrations reaching their highest level in nearly 800000 years and sea level rise reaching their fastest rate in nearly 2000 years.
Although these phenomena have occurred frequently, it is difficult for people to have the motivation to solve these problems, as the serious impacts of climate change may only occur in subsequent generations. This cycle exceeds the duration of monetary policy (2-3 years) and credit cycle (10 years), and it may be too late when it becomes a problem affecting financial stability.
Impact of Climate Change and Financial Stability
The Global Financial Stability Board has begun to require regulatory agencies to consider the risks posed by climate change to the financial system. Climate change can affect financial stability in three directions:
- Physical risk: it refers to the direct impact of climate events on assets, such as damage to property caused by floods and storms;
- Liability risk: it refers to the risk that when victims of climate change demand compensation, and liability insurance is the financial subject that may be affected;
- Transition risk: it refers to the risks that arise during the process of adjusting to a low-carbon economy. This kind of risk stems from the revaluation of assets due to changes in policies and technology;
These three risks will affect the enterprises and customers served by the financial industry, and ultimately pose pressure on the operational performance. When the risks occur widely, the entire financial system will face pressures.
Addressing Financial Risks from Climate Change
To solve the problem of climate change, we can start with greenhouse gas emissions. The Carbon Disclosure Project (CDP) has disclosed carbon emissions information of over 5000 companies to financial institutions managing $90 trillion assets. The United Nations Intergovernmental Panel on Climate Change (IPCC) is also developing a carbon footprint disclosure framework to help businesses manage carbon risks.
More than 400 institutions worldwide are providing these data, but there are significant differences in their current status (legal regulations or voluntary guidance), business scope (greenhouse gas emissions or whole environmental risk indicators), and measures (information disclosure or climate change mitigation). This may cause the financial system to get lost in the right direction.
An effective climate change disclosure system needs to include the following features:
- Consistency: Maintain consistency in the scope and objectives of relevant industries;
- Comparability: allows for the evaluation of peer performance and overall performance;
- Reliable: The data involved in the disclosure is true and reliable;
- Clear: Disclosure can simply present information;
- Efficiency: Disclosure can reduce costs;
These characteristics require the participation and coordination of the Financial Stability Board, and require regulatory agencies to adjust related disclosures in subsequent policies. Effective disclosure rules can provide assistance in addressing the tragedy of horizon and increasing financial stability.