Health check - JOURNALIssue 4, April 2021 - Why central banks need to stress test climate risks - OMFIF
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JOURNAL Issue 4, April 2021 Health check Why central banks need to stress test climate risks
2 CONTENTS SPI JOURNAL_APRIL 2021
JOURNAL
Issue 4, April 2021
Health check 8 Pilot exercises help 14
plan for climate transition
Laurent Clerc, director for
research and risk analysis at
the French Resolution and
Prudential Control Authority,
Banque de France
6-9 Snow Hill, London
EC1A 2AY, United Kingdom
T: +44 (0)20 700 27898
omfif.org/spi @OMFIF
ECB needs to rethink 15
spi@omfif.org market neutrality
Olaf Sleijpen, executive board
Danae Kyriakopoulou member of De Nederlandsche
Chair, SPI and Chief Economist
& Director of Research
Danae Kyriakopoulou, chief Bank
Levine Thio
Research and Programmes, economist and director of
Beyond green and brown: 16
Asia Pacific
research, OMFIF
Clive Horwood a principles-based taxonomy
Managing Editor and Deputy
Chief Executive Officer Designing financial 11 Jessica Chew, deputy governor,
Simon Hadley systems for a healthy planet Bank Negara Malaysia
Director, Production
Margaret Kuhlow, finance practice
William Coningsby-Brown Supporting sustainable 17
Assistant Production Editor leader, WWF, and Thomas
finance in Mexico
Sarah Moloney,
Vellacott, CEO, WWF Switzerland
Fergus McKeown Rafael del Villar, chief adviser to
Subeditors
the governor, Banco de México
John Orchard Accurate risk measurement 12
Chief Executive Officer
crucial to net-zero transition
David Marsh Central banks can help 18
Chairman Paul Hiebert, head of systemic
finance renewables
Mingiyan Shalkhakov risk and financial institutions
Commercial Director, SPI Gábor Gyura, head of
Strictly no photocopying is
division, European Central Bank sustainable finance, Magyar
permitted. It is illegal to reproduce,
store in a central retrieval system
Nemzeti Bank
or transmit, electronically or
otherwise, any of the content of Climate enters IMF’s 13
this publication without the prior
consent of the publisher. While risk analysis Managing climate risk 19
every care is taken to provide
accurate information, the publisher
cannot accept liability for any errors
Tobias Adrian, financial uncertainty with technology
or omissions. No responsibility will
be accepted for any loss occurred
counsellor and director, Vikram Edmund Lau, deputy chief
by any individual acting or not acting
as a result of any content in this Haksar, assistant director, and executive, Hong Kong
publication. On any specific matter
reference should be made to an James Morsink, deputy director Monetary Authority
appropriate adviser.
Company Number: 7032533.
of the monetary and capital
ISSN: 2398-4236
markets department, IMF Forthcoming meetings 20
OMFIF.ORG/SPI LEADER 3
We can’t self-isolate from
climate change
Central banks have a vital role to play in supporting the net-zero transition. Many are beginning
to incorporate climate considerations in their activities. But the conversation needs to pick up
speed, writes Danae Kyriakopoulou, chief economist and director of research at OMFIF.
T HIS VOLU M E of the journal comes one year on from when
most countries introduced lockdown measures to contain the
spread of Covid-19. The anniversary is an opportunity to reflect
on the way businesses, individuals and governments have
adjusted to living in a new reality. ‘Addressing the climate
Two lessons stand out. First, countries that followed the crisis requires early
science have generally been assessed to have better weathered the action in line with the
pandemic shock, both in terms of the health of their population science. But unlike the
and their economies. Second, preparing for tail risks and acting virus, the climate crisis
early helps to contain the virus and its consequences. is not one we can self-
Similarly, addressing the climate crisis requires early action
isolate from.‘
in line with the science. But unlike the virus, the climate crisis is
not one we can self-isolate from. It requires adjusting our ways
of living and working, and not just temporarily. As the February
edition of this journal demonstrated, many economies are already
suffering the consequences through heightened frequency and
intensity of natural disasters. Gradual changes in temperatures
are also beginning to show, for example in this winter’s unusual
and sudden switches from heatwaves to snowstorms across the
Mediterranean, Texas and the Levant.
Central banks have been a key actor during the pandemic,
ensuring that the health crisis does not become a financial one as
well. Old fears of an ‘empty toolbox’ have given way to innovative
support packages, stretching the concept of ‘unconventional’
policies. Central banks have a similar duty to respond to the
looming financial implications of the climate emergency through
physical and transition risks.
Encouraging steps are being taken across the community, from
climate stress tests of financial institutions (pg 12 and 14) and
developing sustainable taxonomies (pg 16), to addressing carbon
bias in portfolios (pg 15) and using artificial intelligence and big
data to track risks (pg 19). Initiatives such as the Central Banks
and Supervisors Network for Greening the Financial System are
setting an example for international co-operation.
These are all important steps in the right direction. But the
window of opportunity to address this existential threat is small.
Now that central banks have broadly achieved consensus and
demonstrated accountability for the role they have to play, the
conversation must focus on speed of action.
4 REVIEW SPI JOURNAL_APRIL 2021 Key decisions by central banks on sustainability, February – March 2021 UK updates Bank of England remit to include net-zero economy Chancellor of the Exchequer Rishi Sunak revealed the updated remit of the central bank’s monetary policy committee in the Spring Budget announced in March. The aim of the update was to reflect the government’s economic strategy for a strong, sustainable and balanced growth that is consistent with the transition to a net-zero economy. Bank of Japan highlights climate risks as a key theme in stress test The Japanese central bank will highlight climate change risks as among the key themes in its bank examinations for the first time. In guidelines on the examinations due in March 2021, the central bank and the Financial Services Agency will analyse the impact of climate risks on financial institutions. Hong Kong Monetary Authority plans to double green bond borrowing ceiling With overwhelming market demand for green bonds in Hong Kong, the central bank plans to double the borrowing ceiling to HK$200bn to explore future issuance in other currencies, project types and channels. European Central Bank shares results from economy-wide climate stress test The preliminary results of the ECB’s stress test identified climate change as a major source of systemic risk. In the absence of further climate policies, the costs to companies arising from extreme events will increase substantially.
OMFIF.ORG/SPI REVIEW 5
Selected central bankers’ speeches
on sustainability
23 March: Lael Brainard (bottom left), member of the board of governors of the Federal
Reserve System on financial stability implications of climate change
21 March: Yi Gang, governor of the People’s Bank of China on China’s monetary policy
space and promoting green finance
© Martin Lamberts/European
17 March: Pablo Hernández de Cos, governor of the Banco de
Central Bank 2019
España on the role of central banks and banking supervisors in
climate action
9 March: Ravi Menon, managing director of the
Monetary Authority of Singapore on the future of
capital being green
3 March: Benjamin E Diokno, governor of Bangko
Sentral ng Pilipinas on the role of capital markets in
championing the sustainability agenda
3 March: Isabel Schnabel, member of the executive
board of the European Central Bank on green
neglect to green dominance
22 Feb: Michelle W Bowman, member of the board of
governors of the Federal Reserve System on economic
inclusion in lower-income communities
22 Feb: Christine Lagarde (right), president of the ECB on the main
policy priorities in investing in our climate, social and economic resilience
18 Feb: Lael Brainard, member of the board of
governors of the Federal Reserve System on
the role of financial institutions in tackling the
challenges of climate change
11 Feb: Klaas Knot, president of De
Nederlandsche bank on getting the Green
Deal done and how to mobilise sustainable
finance
11 Feb: François Villeroy de Galhau, governor
of Banque de France on the role of central
banks in greening the economy
6 REVIEW SPI JOURNAL_APRIL 2021
FURTHER READING
Selected reports on climate change and sustainable finance, February – March 2021
MARCH FEBRUARY
EU Platform on Sustainable Finance – United Nations Environment Programme
Transition Finance Report Finance Initiative – Rising Tide: Mapping
The report sets out the platform’s key findings and Ocean Finance for a New Decade
recommendations by responding to six questions from The report maps the current state of ocean finance and
the European Commission. reveals trends in lending, underwriting and investment
activities that impact the ocean.
WWF: Bankable Nature Solutions
The publication introduces 13 case studies that offer Vivid Economics – Greenness of Stimulus
different solutions for generating a financial return and
positively impacting nature and climate change.
Index
The report assesses the effectiveness of Covid-19 stimulus
efforts by G20 countries in ensuring an economic recovery
World Bank Group – Enabling Private that takes advantage of sustainable growth opportunities
Investment in Climate Adaptation and and builds resilience through the protection of climate and
Resilience biodiversity.
The report proposes a blueprint for action to develop,
finance and implement priority adaptation and
resilience investments.
Finance for Biodiversity Initiative – The
Dasgupta Review: What it Means for the
Magyar Nemzeti Bank – Green Finance Global Financial System
Report The review sets out the arguments for action on biodiversity
and highlights the need to identify and reduce financial flows
This report on the sustainability of the Hungarian
that directly harm and deplete natural assets.
financial system aims to increase transparency and
strengthen market awareness of environmental
sustainability considerations. Climate Policy Initiative – The Potential for
Scaling Climate Finance in China
European Commission – Assessment of The report provides an overview of the potential for climate
Biodiversity Measurement Approaches finance, green finance and innovative finance to accelerate
for Business and Financial Institutions China’s decarbonisation and support its transition to a green
This update report reflects on the development of economy.
biodiversity assessment approaches for businesses and
financial institutions and provides case study analysis.
Federal Reserve Bank of San Francisco –
Climate Change is a Source of Financial Risk
SUERF – Greening the UK financial Senior policy advisor and Executive Vice President, Glenn
system – a fit for purpose approach D Rudebusch, highlights the climate risks and the steps the
The policy note proposes an approach for the UK Federal Reserve is taking to mitigate and manage these
financial system to support climate economic policies risks in an economic letter that includes microprudential and
instead of undermining them. macroprudential oversight.
Central Banks and Supervisors Finance for Biodiversity Initiative – Greening
Network for Greening the Financial Sovereign Debt: New Paper: Building a
System – Adapting central bank Nature and Climate Sovereign Bond Facility
operations to a hotter world
The report sets out a proposal to establish a nature and
The report examines the implications of climate change climate sovereign bond facility, providing governments and
for central banks’ operational frameworks and outlines investors with the tools to recognise nature’s contribution
options available for factoring climate-related risks into to long-term sustainability and economic performance, and
their monetary policy operations. urgent solutions to the debt crisis.
OMFIF.ORG/SPI REVIEW 7
OMFIF’s latest sustainable finance activity
Reports Commentaries
Commentaries published in February and March covered a
Gender Balance Index 2021 variety of issues, from gender and celebrating International
Women’s Day, to new areas of sustainable investments and
regional progress in the green transition.
18 March: Tamara Singh and Masamoto Kenichi: Asia
is ready to invest more in Central America
15 March: Natalia Ospina and Levine Thio: Financial
policy-makers weigh in on gender balance
16 March: Simon Ogus: ESG criteria are distorting
markets and portfolio decisions
11 March: Gary Smith: Green push puts CBDCs
centre stage
10 March: Håvard Halland and Diego López: New
Zealand sets climate benchmark for Norway
9 March: Ana Botín: A ‘she-cession’ hurts us all
5 March: Phillip Moore: Raskin says US ready to lead
in climate battle
4 March: José González-Páramo: EU can’t go it
alone in green transition
3 March: Elliot Hentov: Biden impact on ESG
investing will go deeper than climate
26 Feb: Makhtar Diop: Private sector’s retreat
jeopardises rebound
In the most comprehensive study to date of diversity at 16 Feb: Danae Kyriakopoulou: ECB market neutrality
the top levels of central banks, sovereign funds, public crumbling
pension funds and commercial banks, only three out of
10 Feb: Lim Cheng Khai: Addressing the protection
540 institutions achieved a perfect GBI score of 100.
gap in Asia
The eighth edition of the index tracks the presence
of men and women in decision-making positions in 9 Feb: Abdulrahman Al Hamidy: Arab financial sector
financial institutions based on a database of almost defends against climate change
9,000 individuals.
Podcasts
Meetings
8 March: Gender Balance Index 2021 launch
8 March: Choose to challenge – Role models
4 March: OMFIF-DZ sustainability symposium
23 Feb: Infrastructure in the Covid-19 recovery
17 Feb: Future of sustainable data and its role in
achieving global sustainability goals Recent podcasts focused on the launch of OMFIF’s eighth
Gender Balance Index, revealing the new components and
3 Feb: OMFIF-SEACEN sustainability roundtable: analysis of the report as well as what we can expect in the
Coming together for sustainability in 2021 main findings.
2 Feb: Sustainable finance outlook for 2021
23 March: Gender balance: is this the best
we can do?
23 Feb: Gender Balance Index 2021
8 HEALTH CHECK SPI JOURNAL_APRIL 2021 Stress testing for net zero Central bankers are talking positively about their role in speeding up the green transition. Now they need to help deliver on carbon goals, writes Danae Kyriakopoulou, chief economist and director of research, OMFIF. A S PU BL IC economic policy-making market incentives and reallocate capital prices, while altering the underlying institutions, central banks and across the economy. structure of our economies.’ supervisors have a two-fold incentive The latter is key in refuting Some central banks have a direct for supporting a managed transition to objections that by adjusting their mandate to support the sustainability a net-zero economy. First, to address actions to account for climate risks, agendas of governments. For example, climate-related risks to the economy central banks are verging into political the European Central Bank has a duty and financial system. Second, to align territory. In most cases, governments under the Treaty of the Functioning their actions with the objectives of have already pledged net-zero of the European Union to support EU government climate policy, or, at a commitments or signed up to the Paris economic policies, and the European minimum, to ensure their actions do agreement. Central banks are adjusting Parliament urged the ECB in its 2020 not directly contradict government their actions to reflect how these annual resolution to take action against climate policy unnecessarily. decisions will impact the financial climate change. The UK has gone a Climate-related disasters and system. As Deutsche Bundesbank step further with Chancellor of the disruption to economic activity President Jens Weidmann remarked in Exchequer Rishi Sunak updating the can affect asset values and create a speech in January, climate change Bank of England’s remit in March 2021 challenges for banks, insurers and and related policies can affect the to clarify that the economic strategy investors. To achieve their climate mandates of central banks ‘as they may of the government includes supporting commitments, governments and have an impact on macroeconomic the transition to a net-zero economy. market participants will have to take and financial variables such as output, With the motivation clear and actions that will inevitably affect inflation, interest rates and asset direction broadly set, the focus has
OMFIF.ORG/SPI HEALTH CHECK 9
now shifted to implementation. prudential policy and supervision. direct effects – better conducting its
What can central banks do? What is Central banks are also investors monetary policy and reducing its own
already being done well and by whom? managing considerable volumes of risks – as well as the indirect effects –
What lessons can others learn? It is assets in their foreign reserves and steering the behaviour of companies
important to recognise that central pensions portfolios. and financial institutions, through its
banks have different duties and In a speech in February, Banque disclosure policy, as well as its asset
priorities. In their monetary policy de France Governor François Villeroy purchase and collateral policies.’
operations, they set interest rates and de Galhau summarised the need to Central banks around the world
conduct unconventional policies such incorporate climate considerations are making progress with plenty of
as quantitative easing. Some also have across different areas. He suggested initiatives scheduled for the coming
a financial stability mandate, including that a central bank needs to ‘target the months (see table).
HONG KONG MONETARY AUTHORITY MONETARY AUTHORITY OF SINGAPORE
Dec 20: Pilot exercise on climate risk stress test covering physical Dec 20: Publication of ‘Guidelines on Environmental Risk
and transition risks. Launch of green and sustainable finance Management’
strategy March 21: Submission of public comments for green and transition
Jan 21: Continuation of work with authorised institutions (AIs) to taxonomy
promote green and sustainable banking in three phases 2020-22: Incorporation of a broader range of climate change-related
July 21: Update of Hong Kong’s Climate Action Plan 2030+ risks as part of future industry-wide stress test
Aug 21: Adoption of the common ground taxonomy June 2022: Results of stress test
First half of 2021: Industry consultation on supervisory requirements
for AIs and participation of AIs in climate stress testing exercise
BANK OF CANADA
Nov 20: Launch of the pilot project on climate risk scenarios
BANK OF ENGLAND
End of 2021: Publication of a report sharing details on specific
Nov 20: Work on stress test regarding design of the exercise and scenarios, methodology, assumptions and key sensitivities
preparation
June 21: Launch of climate stress test exercise
Sept 21: First submission of firms’ risks BANK OF JAPAN/JAPAN FINANCIAL
Dec 21: Second submission for system-wide impacts SERVICES AGENCY
Q1 2022: Publication of results Dec 20: Publication of ‘Supervisory Simultaneous Stress Testing
Based on Common Scenarios’ with banking regulator, Financial
Services Agency
EUROPEAN CENTRAL BANK April 21: Basic principles for transition finance
Nov 20: Publication of a guide on climate-related and environmental
risks
March 21: End of European single access point consultation. BANQUE DE FRANCE/FRENCH PRUDENTIAL
Preliminary results of economy-wide climate stress test SUPERVISION AND RESOLUTION AUTHORITY
April 21: Launch of non-financial reporting directive review. Adoption
(ACPR)
of the first set of taxonomy technical criteria
April 21: Publication of results of the first climate stress test by ACPR
May 21: Standing facilities platform consultation on taxonomy
objectives beyond climate
June 21: SF platform report on harmful activities (taxonomy) RESERVE BANK OF AUSTRALIA/AUSTRALIAN
July 21: Adoption of the Renewed Sustainable Finance Strategy PRUDENTIAL REGULATION AUTHORITY
Aug 21: ESAP proposal Feb 21: Climate change supervisory review. Release of APRA’s
Oct 21: SF platform report on a social taxonomy supervision and policy priorities for 2021
Dec 21: Adoption of the second set of taxonomy technical criteria Aug 21: Stress test in the second half of the year
Jan 2022: Delegated acts on climate change mitigation and
adaptation apply
2022: New supervisory stress test focusing on climate-related risks
MAGYAR NEMZETI BANK
and reviewing banks’ practices Jan 21: Taxonomy development
BANCO DE MÉXICO BANCO CENTRAL DO BRASIL
Sept 20: Launch of sustainability agenda to embed climate issues Sept 20: Announcement of climate stress test
into policies on currency reserves management, stress tests and April 2022: Results of stress test
lending criteria
10 HEALTH CHECK SPI JOURNAL_APRIL 2021
Monetary policy: inflation dynamics further easing of monetary policy, but the management of their assets, both
and asset purchases rather a recalibration of its tools.’ in terms of their monetary portfolios
Several central bankers have as well as their foreign exchange
highlighted the channels through Supervision: stress tests and reserves and other assets, such as staff
which climate change and the remedial scenario analysis pensions. Weidmann and Member of
actions needed to tackle it affect The potential of climate risks to the Executive Board of the Deutsche
their primary mandate of managing develop into financial stability risks has Bundesbank Sabine Mauderer have
inflation. At a conference in March, been the primary lens through which been vocal in suggesting that central
Banco de España Governor Pablo central banks have acted on climate banks ‘should make sure that climate-
Hernández de Cos noted the impact change thus far. At the microprudential related financial risks are given
‘on the so-called natural interest rate, level, several supervisors have begun due consideration in their own risk
which is an important benchmark preparing and conducting climate management’ and that they should
for inflation targeting central banks stress tests, including those of France, ‘consider only purchasing securities
when setting our interest rates’. the UK, the Netherlands, Canada and or accepting them as collateral for
ECB Executive Board Member Isabel the ECB (see pages 12 and 14). monetary policy purposes if their
Schnabel suggested in an online As Bank of England Governor issuers meet certain climate-related
seminar that climate change may Andrew Bailey remarked during a reporting obligations’.
‘hamper monetary transmission speech in November, central banks are This is easier said than done. Most
due to stranded assets, by affecting ‘not only concerned with resilience central banks face constraints in
potential growth and the natural real at a micro-level, but also at a macro- terms of the types of assets they can
interest rate, or by causing greater invest in, with a strong preference for
macroeconomic volatility’. liquidity and safety over returns. Some
Yet while there is widespread ‘Lack of recognition express concerns that excluding certain
recognition that climate change is not the problem. assets from their portfolio could lead
affects monetary policy, few central What is lacking is to concentration or liquidity risks in
banks are adjusting their operations to consistent and credible the absence of suitable alternatives,
account for this. Weidmann observed with the sustainable finance market
that, at a minimum, central banks
implementation.’ still very small compared to the
need to ‘embed climate-related risks Jens Weidmann, President, overall investment universe. Further
and developments in monetary policy Deutsche Bundesbank, constraints include data gaps and
analyses and update analytical and 11 Nov 2020 challenges, including sustainability
forecasting toolkits accordingly’. taxonomies and disclosures.
There are several options for Finally, central banks can also
positive action, especially for level’. At the macrofinancial level some contribute to the sustainable finance
central banks with asset purchasing are conducting scenario analysis and ecosystem and infrastructure. As
programmes and lending operations exploring the potential for climate Schnabel has suggested, ‘central banks
that can be adjusted to reflect risks to become systemic. The US can play an important catalyst role
sustainability criteria. This applies Federal Reserve, until now largely an in speeding up the green transition
to corporate bond purchasing outlier among central banks for its and in supporting the development
programmes, collateral frameworks mostly passive attitude to addressing of the “green” market segment’.
for lending to commercial banks, climate risks, has set up a Supervisory In Asia, central banks in China,
funding and refinancing operations Climate Committee to lead efforts Malaysia and Indonesia are in the
(some of which are already targeted to address climate risks. Board of process of developing sustainable
to support particular segments of the Governors Member Lael Brainard taxonomies with PBoC Governor Yi
economy such as small and medium- remarked in February that the Fed is Gang highlighting this as ‘the basis for
sized enterprises) and differentiated ‘closely following the climate scenario identifying green economic activities
reserve requirements. For example, the developed by other central banks and and channelling funds to green
People’s Bank of China has introduced supervisory authorities and engaging projects’.
a framework whereby interest rates with those institutions so we can learn This edition of the SPI journal
given to a bank on its required reserves from their experiences’. features articles from seven central
may be increased if the bank obtains a banks expanding further on their
positive green assessment. Portfolio management: reserves and initiatives and objectives. We thank
Overall, as remarked by Villeroy de asset management them for their contributions and look
Galhau, ‘the greening of the central The third area where central banks can forward to engaging further on this
bank’s actions does not require a incorporate climate considerations is important agenda. •OMFIF.ORG/SPI HEALTH CHECK 11
Designing financial
systems for a healthy planet
Margaret Kuhlow, finance practice leader, WWF, and Thomas Vellacott, CEO, WWF Switzerland,
explain how the financial sector is starting to respond to the threat of climate change.
THE Covid-19 pandemic is a wake-up We collaborate closely with central regulations and policies against the
call. Catastrophic as it has been for banks, financial supervisors and framework will be publicly available
livelihoods and economies, its impacts policy-makers to help translate their on an interactive online platform,
may pale in comparison to those ahead commitments on climate change facilitating comparison between
if we continue to disregard the health into action. Our research on nature- countries and evidencing progress
of the planet and weaken natural related risks reveals their potential made.
systems. for significant economic and financial Later this year, we will co-
As we lose natural diversity and impacts. We are calling for: publish a paper on environmental
degrade ecosystem services, we • assessment and management of risks driven by biodiversity loss as
radically restrict our opportunity to climate-related and environmental a source of systemic financial risk.
harness nature-based solutions to financial risks; This research will offer a scientific
tackle climate change. These risks • regulatory action and a precautionary basis for meaningful dialogue with
could catastrophically destabilise approach to mitigating these risks; and key stakeholders on the financial
our financial system and present • adaptation of financial regulation implications of biodiversity loss. We
an existential threat to the global to fully consider all risks and ensure will provide regular overviews on
economy and our future prosperity. harmonisation and convergence of data, tools and methodologies that
The good news is that the financial practices. can be used by financial institutions
sector is starting to respond to to quantify, understand and measure
climate-related financial risks. The environmental risks.
Central Banks and Supervisors To mitigate the devastating risks
Network for Greening the Financial ‘As we lose natural of irreversible climate breakdown and
System is acknowledging finance diversity and degrade catastrophic nature loss, financial
regulators need to act swiftly. Delaying
as a powerful tool for change. Its ecosystem services, we action will only exacerbate growing
goal is to share best practice on
aligning financial flows with the Paris radically restrict our climate-related and environmental
agreement. opportunity to harness risks, prolonging uncertainty in
financial markets.
Now, with COP26 in Glasgow just nature-based solutions Our Greening Financial Regulation
around the corner, there are growing
global expectations for promises to to tackle climate change.’ initiative seeks to demonstrate that
be translated into action. If world designing a financial system for a
leaders choose to build a truly resilient healthy planet is an indispensable part
recovery from Covid-19, 2021 could To benchmark current practices, we of building a resilient, nature-positive
be the decisive year in which we make published the Sustainable Financial global economy ready to respond to
progress on mitigating climate change Regulations and Central Bank Policies emerging risks, and able to invest
while also addressing biodiversity loss. framework which helps assess the in bankable nature solutions and
At WWF, the world’s largest policies and actions that central opportunities.
science-based conservation banks, regulators and supervisors in Working closely with our partners
organisation, we are encouraging the 40 countries are adopting to create and responding to the challenges they
financial sector to direct financial a greener financial system. The face, we aim to offer central banks,
flows towards nature-positive framework also provides a roadmap financial supervisors and policy-
investments and activities. A key for financial regulators to take into makers clear analysis and practical
focus is on accelerating the transition account environmental and social insights on sustainable finance,
towards future-fit regulatory risks and enhance the stability and enabling them to make the bold
conditions that help systematically resilience of the financial sector. revisions to financial regulation that
mobilise green capital. Country-level assessments of relevant we need to avert future crises. •12 HEALTH CHECK SPI JOURNAL_APRIL 2021
Accurate risk measurement
crucial to net-zero transition
Addressing data gaps and expanding financial modelling are the two key building blocks in
improving measurement, writes Paul Hiebert, head of systemic risk and financial institutions
division, European Central Bank.
T H E impact of climate change on (selection bias in firm reporting), action on climate risk, including
the financial system is set to be inconsistent (lack of accepted adaptation and mitigation measures
profound. The costs of physical methodology for defining green of governments, will have net
damage could reach up to one- and brown assets) and insufficient benefits. Along the path to a less
quarter of global gross domestic (virtually no reporting on carbon-intensive economy, financial
product by the end of this century, downstream emission intensity of institutions will be exposed to risk –
amid considerable uncertainties products of portfolios). This leads which needs to be managed.
around amplifying dynamics and to informational market failures, Improving the foundations for
so-called ‘tipping points’. Managing irrespective of prospective allocative more accurate and encompassing
these costs is no mean feat. market failures. As financial market measurement of the financial
The transition to a low-carbon capacity builds, there may be risks posed by climate change will
economy will also entail upfront scope for market overshooting and require two main building blocks.
investments, requiring $1.4tn possible pricing dislocations. First, data gaps constraining fully
when considering the energy sector Faced with the prospect of representative analysis need to be
alone, or up to $20tn when looking financial shocks resulting from tackled. Several initiatives in this
at the economy more broadly. The climate change, ensuring the area, supported by the Central
impact of climate change will be Banks and Supervisors Network for
highly path-dependent – timely Greening the Financial System, hold
intervention can stem the rise in considerable promise. Granular data
temperatures accompanying carbon ‘Along the path to a are needed – both geolocational, to
emissions. less carbon-intensive evaluate susceptibility to climate
Financial flows will be a key risk, and forward-looking metrics
economy, financial
factor in economic adjustment. of transition intensity to a net-zero
Specifying near-term risks to institutions will be economy, as the financial system
financial intermediaries as well as exposed to risk – which inevitably shifts.
risks entailed by lending remains needs to be managed.’ Second, efforts are needed to
a work in progress. Within the meaningfully expand available
European Union, the European financial modelling for climate
Systemic Risk Board has been tasked analysis – notably the ability to cost
with analysing this measurement, resilience of the financial system out long-term tradeoffs between
drawing insights from granular remains a key priority. Exposures physical risks of climate change and
supervisory datasets matched of euro area banks to high- mitigating transition efforts.
with available carbon emissions emitting firms appear limited on As the old adage goes ‘what can
reporting, geospatial data and average, but concentrated in a few be measured, can be managed’.
economic and financial models large exposures for some banks. As rapidly evolving work in risk
to gauge potential risks to the 19 Although many of the risks have measurement matures in central
countries comprising the euro area. yet to materialise meaningfully banks and supervisors, as well
Financial markets – while on the balance sheets of financial as the broader public and private
seemingly willing to price climate- institutions, standardised sector, the foundations are being
related risks – are unable to fully exploratory scenario analysis can be laid for timely and effective action to
reflect this risk in prices owing to an indispensable tool. tackle this fundamental issue of our
disclosures that are incomplete Research shows that early generation. •OMFIF.ORG/SPI HEALTH CHECK 13
Climate enters IMF’s
risk analysis
Analysing climate risk scenarios can strengthen the resilience of the financial system,
explains Tobias Adrian, financial counsellor and director, Vikram Haksar, assistant director,
and James Morsink, deputy director of the monetary and capital markets department, IMF.
T H E Financial Sector Assessment risk diagnostic to decide on the and transition risks. Physical risks are
Programme is a comprehensive scope of the assessment and relevant especially relevant for many of the
analysis of a country’s financial physical and transition risks for any IMF’s smaller and more vulnerable
sector. It assesses the resilience of the given country. Second, designing members and will require close co-
sector, the quality of the regulatory climate scenarios. And third, operation with climate scientists.
and supervisory framework and designing macrofinancial scenarios The highly microsectoral and
the capacity to manage and resolve and using them to assess bank geospatial sources of climate-related
financial crises. The International resilience in a similar way to standard financial risks present important
Monetary Fund is adapting the FSAP bank stress tests. This will data and modelling challenges. The
FSAP to address challenges posed by require adapting the conventional uncertainties surrounding carbon
climate change. approach to stress testing in several pricing and associated spending of
Using FSAPs to analyse climate ways. carbon tax proceeds also present
risk scenarios can help our members Our climate risk scenario analysis modelling challenges for assessing
better understand physical risks to will consider financial stability risks transition risks.
the financial system and manage the over the medium term (three to five The immensity of the climate
transition to a low-carbon economy. years) and the long term (30 to 50 challenge calls for global co-
The analysis informs policies for years), given the nature of climate operation. The IMF will work closely
enhancing risk management and risks. Many institutions are only with the United Nations, the World
resilience. Unlike conventional stress focusing on long-term risks. We focus Bank, the Financial Stability Board,
testing, climate risk scenario analysis on the medium term as well, because the Central Banks and Supervisors
is not focused on quantifying possible financial markets and institutions Network for Greening the Financial
needs of financial institutions relative could adjust early on to risks from System and other international
to minimum capital requirements. potential long-term climate impacts. standard-setting bodies to address
FSAP risk analysis has captured FSAPs will consider both physical this crisis. •
physical risks, such as insurance
losses and non-performing loans
associated with storms, floods and
droughts. This has become common
in FSAPs for small island states (such
as the Bahamas, Jamaica and Samoa) ‘Many institutions
and other countries prone to natural
disasters.
are only focusing on
FSAPs for systemically important long-term risks. We
financial sectors (such as Belgium, focus on the medium
Denmark, France, Sweden and the
US) have also typically covered
term as well, because
natural catastrophe risks as part of financial markets and
insurance stress testing. More recent institutions could
FSAPs have assessed both transition
risks (Norway in 2020) and physical
adjust early on to risks
risks (the Philippines in 2021) and we from potential long-
intend to expand this in the coming term climate impacts.’
year.
We are taking a three-stage
approach. First, a climate financial14 HEALTH CHECK SPI JOURNAL_APRIL 2021
Pilot exercises help
plan for climate transition
The climate pilot exercise aims to make the financial system more aware of climate risks, explains
Laurent Clerc, director for research and risk analysis at the French Resolution and Prudential
Control Authority, Banque de France.
T H E French Resolution and (representative concentration domestic product, inflation and
Prudential Control Authority pathway 8.5). employment) at both national
(ACPR) launched its first climate For insurers, physical risk is and international levels. These
pilot exercise last July. It aims assessed at the municipal level for results feed into a general sectoral
to measure climate change risks domestic liabilities. The exercise equilibrium model, which enables
and raise financial institutions’ includes the assumption of an
the economic activity of a given
awareness of them. increased probability of pandemics
This exercise is the first of its and the development of pathologies
kind. It covers a 30-year period related to the deterioration of air
(2020-50), far beyond the traditional quality in urban areas consistent ‘The ACPR aims to
three to five-year window of with more frequent and intense heat measure climate
standard exercises. It takes into waves. change risks and raise
account the global nature of climate The exercise combines static financial institutions’
change at sectoral level, covering at (until 2025) and dynamic (2025-50)
awareness of them.‘
least 80% of the global exposures of balance sheet assumptions, enabling
French banks and insurers. firms to mitigate the impact of
It relies on four scenarios: three climate change on their balance
for assessing transition risks, two sheets and reduce their emissions. country to be broken down into 55
of which rely on the high-level It is a voluntary exercise, with no sectors for each scenario.
scenarios published by the Central implications in terms of capital This sectoral model relies on
Banks and Supervisors Network for requirements. a global input-output matrix,
Greening the Financial System last To provide financial institutions combining energy and non-energy
June, and one for assessing physical with relevant data, ACPR and the inputs from all countries with
risks, corresponding to the worst Banque de France developed an the domestic labour factor. The
scenario of the Intergovernmental analytical framework based on a suit outcomes of this sector block, when
Panel on Climate Change of models. It starts with the NGFS combined with the macroeconomic
high-level scenarios resulting from and financial projections, feed into
the projections of several integrated a credit risk rating model, which
assessment models. These estimates the default probabilities
‘This exercise takes into projections are used to calibrate the of companies, and a financial
account the global nature transition shocks from carbon taxes module, which generates projections
and productivity developments,
of climate change at of asset prices, yield curves and
thanks to an international general
sectoral level, covering credit spreads for each scenario and
equilibrium model. geographic area.
at least 80% of the global
This model then generates The results of the climate pilot
exposures of French
the relevant macroeconomic and exercise will be published in April
banks and insurers.‘ financial variables (such as gross 2021. •OMFIF.ORG/SPI HEALTH CHECK 15
ECB needs to rethink
market neutrality
It’s time to address market failures and carbon bias in financial markets, writes Olaf Sleijpen,
executive board member of De Nederlandsche Bank.
DR ASTIC efforts are needed Second, central banks may What is appropriate may differ for
to reduce carbon emissions and consider making climate disclosures each central bank, dependent on its
meet the climate goals of the Paris a requirement in their monetary mandate and the type of monetary
agreement. While governments operations (both in refinancing operations. The ECB has to consider
are the driving force behind the operations and purchase how to take into account climate-
transition to carbon-neutral programmes). This transparency related risks in monetary policy,
economies, central banks have an would help central banks improve because climate change can directly
important role to play in identifying their assessment of climate risks. and indirectly affect price stability.
and reducing climate-related risks. Central banks should also The ECB also has to support general
These risks are often not consider addressing carbon bias in economic policies in the European
accurately priced in financial their monetary operations, which Union, one of which is ‘a high level of
markets. This is mainly due to comes from carbon bias in financial protection and improvement of the
inadequate carbon pricing and markets. For example, the European quality of the environment’. In its
incomplete information about Central Bank applies the concept strategy review, the ECB is exploring
climate-related exposures. As a of market neutrality in its purchase how, within the boundaries of its
result, financial markets do not fully programmes. However, market mandate, it can consider climate-
internalise expected costs of climate neutrality in the form of a market related risks in the conduct of its
change and climate-related policies capitalisation weighted benchmark – monetary policy.
in asset prices. This market failure as used in the ECB’s corporate sector So, although governments are the
leads to inefficient allocation of purchase programmes – may not primary actors in climate-related
resources and carbon bias in capital be appropriate. Market failures that policies, central banks have an
markets. distort relative prices may be a reason important role to play in fostering
The most direct way to address to use other concepts of market transparency and in the way they
this is for governments to introduce neutrality that better reflect climate- shape their monetary policy and
better carbon pricing measures. This related risks and externalities. operations. •
will force markets to internalise
climate-related externalities and
make sustainable investments more
attractive compared to carbon- ‘Market failures that distort relative
intensive alternatives.
Global accounting standards for
prices may be a reason to use other
climate risks are needed to foster concepts of market neutrality that
better transparency and address better reflect climate-related risks
information gaps in markets. Central and externalities.’
banks can contribute to this in two
ways.
First, they can disclose the
climate-related risks of their balance
sheets. This sets an example and
could encourage the disclosure of
such risks by other financial market
participants.16 HEALTH CHECK SPI JOURNAL_APRIL 2021
Beyond green and brown: a
principles-based taxonomy
The rollout of the new taxonomy in Malaysia can be used to manage climate risks and strengthen
financial resilience, explains Jessica Chew, deputy governor, Bank Negara Malaysia.
BA N K Negara Malaysia recognises services is sustained. The taxonomy common exposures to climate-
the urgent need to effectively encourages financial institutions to related risks as well as challenges in
manage climate risks given the help businesses transition to greener mitigating such risks.
wider ramifications for the financial practices in a way that improves The majority of Asean countries
sector and the economy. In preparing rather than erodes development are resource-based economies with
the Malaysian financial system to outcomes and helps build capacity higher risks of stranded assets if
become more climate-resilient, BNM within businesses to better manage disorderly transition occurs. Most
supports an orderly transition that is climate-related risks. are also developing countries,
consistent with preserving inclusive Another important component with substantial needs for funds,
financial services for households and is the development of a sectoral expertise and technology to support
businesses. and activity impact-based risk an orderly transition. BNM therefore
To achieve this, BNM believes management toolkit. To start sees great value in pursuing a
that measures to strengthen with, the focus is on palm oil, coordinated and regionally coherent
climate resilience must also renewable energy and energy financial sector response to the
provide meaningful support and efficiency activities, followed by climate challenge.
viable solutions to help businesses manufacturing, construction and To this end, BNM is working
transition towards green activities infrastructure, as well as oil and gas closely with central banks in the
and operations. It is particularly by the end of the year. region on building a regional
important for a country like Malaysia Within the Association of taxonomy. The rollout of the
to minimise significant social and Southeast Asian Nations region, Climate Change and Principle-
economic dislocations that can arise BNM has been supportive of the based Taxonomy in Malaysia
from the premature exclusion of development of a taxonomy that combined with other relevant
certain sectors or economic agents. can provide a common language for experiences of regional economies
BNM’s immediate priorities are to sustainable finance and promote will be particularly instructive in the
build a strong foundation in climate efficiency. Asean economies share process. •
risk management for the financial
industry. An important step is the Key features of the Climate Change and Principle-based Taxonomy
development of a principles-based Five Guiding Principles for capturing the impact of economic activities and
business operations on the climate and the broader environment 1. Key features
taxonomy to inform risk assessments
and direct financial flows to of the Climate
Activities that do no
activities that support the transition Activities that contribute
to climate change
Activities that contribute
to climate change
significant harm Change and
to the environment
to a low-carbon and climate-resilient mitigation adaptation
Prevent and control Principle-based
Avoid GHG emissions; Implement measures
economy. Reduce GHG emissions; to increase own
pollution; Taxonomy
resilience; or Protect ecosystem and
or
As opposed to a green or brown Enable others to avoid or Enable other
biodiversity; and Five guiding
Sustainable and
binary assessment, a principles- reduce GHG emissions economic activities to
efficient use of natural
principles
adapt to climate
based approach supports businesses change resources for capturing
the impact of
in transition by recognising climate Business operations that
demonstrate remedial
Economic activities
economic activities
risk mitigation and adaptation efforts to promote
transition
must not be
prohibited activities and business
efforts over time while ensuring Support transition efforts Not illegal and do operations on
through the
assessments are rigorous. This implementation of action
not contravene laws
the climate and
approach combines assessments plans and remedial the broader
measures towards
at economic activity level and sustainable practices environment.
overall business level to ensure Source: Bank
progress towards greening financial Negara MalaysiaOMFIF.ORG/SPI HEALTH CHECK 17 Supporting sustainable finance in Mexico Rafael del Villar, chief adviser to the governor, Banco de México, explains the role of the Sustainable Finance Committee in encouraging financial institutions to integrate climate risks in decision-making. IN RECENT YEARS, Banco de considers social aspects and several goal is for regulators and financial México has been actively promoting sustainable development goals. institutions to integrate financially and supporting financial institutions It is internationally comparable, material environmental data and in the adoption of measures that particularly for financing green forward-looking methodologies and integrate climate and environmental, activities. tools in their decisions. social and governance risks and The mobilisation WG will provide Finally, the disclosures WG is opportunities in decision-making. more visibility to sustainable analysing different ESG standards, In May 2020, together with activities and technologies. In mindful that existing standard the United Nations’ development addition to taking stock of such fragmentation may increase and environment programmes, activities, it will evaluate the role that reporting costs for firms. This WG BdM published ‘Climate and development banks, as well as other closely monitors international Environmental Risks and possible actors, have in promoting the financial institutions, such as the Opportunities of the Financial System adoption of material ESG practices by International Financial Reporting of Mexico’, an in-depth report on the listed and non-listed firms. Standards, International Organization state of awareness and consideration The ESG risk WG is looking into of Securities Commissions and of ESG and climate-related risks ways to accelerate the inclusion Federation of Small Businesses. by Mexican financial institutions. of climate-related risks and It assesses the work done on the The study was based on a detailed opportunities in decision-making adoption of recommendations survey and in-person interviews with processes of financial institutions. made by the Task Force on Climate- the senior management teams of Currently, the risks associated related Financial Disclosures and on financial institutions. It provided an with climate change are not fully embedding sustainability risks into assessment of drivers and challenges, incorporated into asset prices. The global accounting frameworks. • as well as a set of recommendations to better align financial flows to a sustainable and low-carbon economy. Last year, Mexico’s Financial System Stability Council (CESF) created the Sustainable Finance Committee (CFS). The CFS will ’The goal is for support the CESF with analysis, regulators and information and guidance on sustainable finance and its financial institutions implications for financial stability. to integrate Members of the CFS include financially material financial authorities and regulators as well as representatives from the environmental data private financial sector. The CFS and forward-looking engages financial market actors methodologies in this agenda, through dialogue, guidance, capacity building and and tools in their regulation. decisions.‘ The CFS has approved four working groups. First, the sustainable taxonomy WG is developing a broad taxonomy that
18 HEALTH CHECK SPI JOURNAL_APRIL 2021
Central banks can help
finance renewables
The energy sector will be key for the transition to a net zero economy, writes Gábor Gyura, head
of sustainable finance, Magyar Nemzeti Bank.
IF CENTRAL banks are going to back to the financial system and even to approaches until now.
seriously address climate risks and individual market players. MNB launched a comprehensive
play a positive role in the transition to Polluting forms of energy production project to identify room for
a net-zero economy, they should look are more exposed to increasingly stricter improvement in the renewable energy
at how the energy sector is financed. environmental regulations and could finance market. The initial analysis
The complexity of the topic calls for therefore be riskier in the long run. The fortunately showed that non-performing
a considered financial regulatory best way to decarbonise the economy loan levels are low in the segment, but
approach and Magnar Nemzeti is for central banks to support green
Bank has just embarked on this journey. there is clearly work to be done to keep
energy production so that industries and
One year ago, with the outbreak of it that way, if such a dynamic growth is
households can be more sustainable.
the Covid-19 crisis, the International foreseen in climate policy plans.
Renewable energy is not without
Renewable Energy Agency’s flagship Through consultations with
environmental challenges (such as
report, ‘Renewable Energy Statistics commercial banks and project
the problem of solar panel waste), but
2020’, laid out a path to creating a developers MNB was able to spell out
sustainable energy system. It suggested in its report, ‘Financing the Hungarian
that by putting renewables at the centre renewable energy sector’, the various
of the recovery from the pandemic, we ‘Current loan level
risks of the segment (such as risks
could align our economies with the Paris credit databases related to the energy market, price,
agreement, unlock a $100tn boost to do not differentiate exchange rate, balancing costs, tenor)
global gross domestic product and create
millions of new jobs by 2050. between loans and start conversations about how such
The Hungarian national strategy financing green risks could be mitigated. The aim is to
(published in early 2020) set ambitious and brown energy support financial stability and the supply
targets for expanding renewable of renewable energy finance. However,
energy power production. By 2040,
production. The the de-risking measures (like a possible
approximately HUF2.2tn ($7.3bn) of new climate lens has been credit guarantee scheme) are not within
investment will be needed (HUF112bn missing from both a central bank’s arsenal.
per year) in the sector, which would
trigger around HUF1.6tn ($5.3bn) of new
banks’ and regulators’ Even if renewable energy production
is not without risks, there is a strong
debt financing. This does not include approaches until now.’
case for differentiating between green
the construction of energy storage
capacities and the cost of network and brown in capital requirements to
development, which also require acknowledge transition risks of non-
central banks should start to implement
significant investments adding up to sustainable energy production. In
green financial policies.
HUF500bn ($1.7bn). December 2020, MNB announced its
In doing so, MNB realised that
Hungary’s GDP is roughly new scheme providing more favourable
energy production loans have so far
$154bn, so such an ambitious growth capital requirements for corporate loans
been ‘colour blind’ in Hungary. In most
plan poses a challenge to the energy financing renewable energy production.
cases banks do not flag renewable
and finance sectors. MNB set the dual
loans within the energy class in their The scheme will last for five years, until
goal of assessing and reducing climate-
data systems. Current loan level credit which time the outcome of the EU’s
related risks for the financial system
to encourage financial institutions databases do not differentiate between debate about whether a differentiated
to operate more sustainably. Green loans financing green and brown energy prudential treatment of green versus
financing can help to mitigate macro- production. The climate lens has been brown assets in the EU banking
level sustainability-related risks, feeding missing from both banks’ and regulators’ framework will be introduced. •You can also read
