Rhiannon Sowerbutts, Vesko Karadotchev, Richard Harris and Evarist Stoja
While communication has been recognised as an important aspect of monetary policy for over three decades and received an enormous amount of attention in the academic literature, there has been almost no attention paid to the importance and effects of financial stability communication. In a new working paper we examine financial markets’ reaction to the Financial Stability Report.
An abrupt transition to a lower-carbon economy might cause disruption in financial markets as the value of energy companies is rapidly reassessed. Last year there was a sea change in attitudes as several funds divested their fossil fuel related assets, equity analysts and rating agencies began to issue warnings about carbon-intensive firms and the Paris Climate Change agreement was hailed as a breakthrough as it made the concept of a carbon budget that would limit future fossil fuel use mainstream. However, analysis of climate related ‘events’ suggests that although energy firms’ equity prices move in the expected direction this movement isn’t statistically significant. This doesn’t mean as global citizens we can relax, either about financial stability or for the future of the planet.
How might banks fare in stressful macroeconomic conditions? Are they strong enough to withstand the stress and survive or will they fall like dominoes? Stress tests offer insights into such questions.
Regulators are not only making a growing usage of such tests, they are also increasingly inclined to communicate openly about them. This is a remarkable evolution. Throughout history, regulators have typically followed some form of Hippocratic Oath and refrained from disclosing their detailed diagnostics of individual banks’ health. Regulators are now increasingly keen to release both the “answer” to stress tests (the results) and the “question” – the stress scenario regulators confront banks with. This column suggests that the disclosure of the scenario can be as important as – if not more than – the disclosure of the results.