Apr 27, 20193 min
My message today is simple. Climate change poses significant risks to the economy and to the financial system, and while these risks may seem abstract and far away, they are in fact very real, fast approaching, and in need of action today.
That’s how Sarah Breeden began her speech titled “Avoiding the storm: Climate change and the financial system” (pdf) yesterday. Breeden is the Bank of England’s executive director of International Banks Supervision and she was speaking at the Official Monetary & Financial Institutions Forum in London.
The urgency in Breeden’s speech was also on display on London’s streets. Earlier in the day, the environmental group Extinction Rebellion blocked traffic in five iconic locations across the city in a peaceful, non-violent protest to bring attention to “inactivity” of governments on fighting climate change.
Breeden adopted the metaphor of sailing in a storm to explain one of the biggest challenges faced by the global financial system.
In short, there are storm clouds on the horizon and the financial system needs to act now to plot a new course to safer waters. To do that we will need three things. Firstly, a destination. Secondly, an able crew. And finally, a nautical chart—or map—to get us there.
The 2015 Paris climate agreement has given us the destination: Keep global warming under 2°C and cut emissions to net-zero within the century. The crew is a group of central banks called the Network for Greening the Financial System (NGFS). But there is no map. “Climate change is an unprecedented challenge and, I am sorry to say, there are no existing charts for us to follow,” Breeden said.
Climate change poses financial risks in two forms, she said:
Physical risks arise from damage to property, land and infrastructure from catastrophic weather-related events and broader climate trends such as heatwaves, hurricanes, droughts, floods and rising sea levels.Transition risks arise from changes in climate policy, technology and market sentiment as we adjust to a lower-carbon economy. The need to transition is widespread, affecting not only energy companies but also transportation, infrastructure, agriculture, real estate to name just a few.
Speaking to professionals in the finance world, Breeden used strong language to express the urgency of acting to fight climate change, using the financial system to aid an energy transition.
First the risks are far-reaching in breadth and scope. They will affect all agents in the economy, in all sectors and across all geographies. Their impact will likely be correlated, and non-linear. They will therefore occur on a much greater scale than other risks.
Second, the risks are eminently foreseeable. I cannot tell you now exactly what will happen and when. But I can say with a high degree of certainty that some combination of physical and transition risk will materialize at some point in the future. Uncertainty about what will happen cannot lead to inaction and inertia.
Third—and for me this is key—the size of those future risks will be determined by the actions we take today. The carbon released today is creating the physical and transition risks of tomorrow. Climate change therefore represents the tragedy of the horizon: by the time it is clear that climate change is creating risks that we want to reduce, it may already be too late to act.
While governments must act through climate policy, Breeden said that the risks are such that it is “incumbent” upon financial firms and central banks to act, too. A lack of action could mean heavy losses, with estimates of between $4 trillion and $20 trillion in asset value destroyed.
Even at the bottom ends of these ranges, losses represent a material share of global financial assets. A climate Minsky moment, where asset prices adjust quickly with negative feedback loops to growth, seems possible.
So what is the Bank of England doing about this? It has set out how banks and insurance companies that it regulates should incorporate climate change in their governance, risk management, forward planning, and disclosure policies.
It won’t be easy or cheap, with the investments needed to transition to a zero-emission world estimated at $90 trillion by 2030, or five times US annual GDP. But “this presents substantial opportunities for the financial sector to develop new products and services to mainstream green finance,” she added.
Breeden returned to her metaphor to conclude her speech:
The financial system appear to me to be like super-tankers rather than high-speed catamarans in the America’s Cup. To change course, therefore, we need early action, a sustained effort and a recognition that it is better to be roughly right now not precisely right when it is too late. We can already hear distant thunder, but we must not wait for the storm to hit.