Policymakers have been investing heavily, to an accelerated timeline, to better understand the financial risks from climate change and to ensure that the financial system is resilient to those risks. Against that background, some commentators have observed that the most carbon-intensive sectors may be subject to the greatest increase in transition risk. They argue that these risks are not currently included within risk weights in the banking prudential framework and that regulators should adjust the framework to include them. Conceptually, this argument sounds credible – so how might UK regulators approach whether to adjust the risk-weighted asset (RWA) framework to include potential increases in risks? This post updates on some of the latest thinking to help answer this question.
There is a lively debate about whether and how capital regulations for banks and insurers should be adjusted in response to climate change. The Bank of England will host a conference later this year to discuss the points in favour of and against adjustments to the regulatory capital framework to take account of climate-related financial risks. The call for papers asks for research on appropriate capital tools to address these risks, eg whether risks point to microprudential tools which are firm specific or rather macroprudential system-wide ones. Moreover, it asks for research on an appropriate time horizon over which the risks should be considered and how scenarios and forward-looking data should be used. This post will review the existing literature and identify some key gaps.
The Coronavirus pandemic and measures to contain contagion had far reaching consequences on economic activities, which also led to a sharp fall in CO2 emissions. This has sparked new debate about how the recovery from the crisis could be made compatible with the Paris climate goals. In this post, I survey the emerging literature on the link between the economic recovery from the aftermath of the pandemic and climate change.
India Loader, from South Wilts Grammar School, is the winner of the third Bank of England/Financial Times schools blog competition. The competition invited students across the UK to write a post on the theme: the economy and climate change.
To help save the planet and gain a competitive edge, cafes should obey a basic rule of behavioural economics by switching from offering discounts for customers who bring their own cups in favour of charging more for disposable ones.
Marco Minasi-Smith, from Fortismere School, London, is the runner-up of the third Bank of England/Financial Times schools blog competition. The competition invited students across the UK to write a post on the theme: the economy and climate change.
While Australia mourns the human and ecological cost of its ‘black summer’ of fires, the tragedy poses a question for economic policy-makers everywhere: how do we prevent climate crises becoming economic ones?
Carsten Jung, Theresa Löber, Anina Thiel and Thomas Viegas
Governments have pledged to meet the Paris Target of restricting global temperature rises to ‘well below’ 2˚C. But reducing CO2 emissions and other greenhouse gases means reallocating resources away from high-carbon towards low-carbon activities. That reallocation could be considerable: fossil fuels account for more than 10% of world trade and around 10% of global investment. In this post, we consider the macroeconomic effects of the transition to a low-carbon economy and how it might vary across countries. While much of the discussion has focussed on the hit to economic activity and the potential for job losses in higher-carbon sectors, we highlight that the transition also offers opportunities. And the overall impact depends crucially on when and how the transition takes place.
Emanuele Campiglio, Yannis Dafermos, Pierre Monnin, Josh Ryan Collins, Guido Schotten and Misa Tanaka
Climate change poses risks to the financial system. Yet our understanding of these risks is still limited. As we explain in a recent paper published in Nature Climate Change, central banks and financial regulators could contribute to the development of methodologies and modelling tools for assessing climate-related financial risks. If it becomes clear that these risks are substantial, central banks should consider taking them into account in their operations. Both central banks and financial regulators might also consider supporting a low-carbon transition in a more active way so as to contribute to the reduction of these risks.
There has been a recent increase in awareness of investors that limiting emissions to prevent climate change might leave a substantial proportion of the world’s carbon reserves unusable, and that this could lead to revaluations across a range of financial assets. If risks are left unaddressed, this could result in large losses for some investors. But is this adjustment in financial market prices likely to be abrupt? And – even if it is – is it likely to pose risks to financial stability? We argue that the answer to both these questions could be yes: financial valuations can move sharply even if the transition to sustainable energy were smooth. And exposures are sufficiently large to warrant attention from both investors and policymakers.