Central banks not ready to follow climate scenarios with tighter rules

October 22, 2021|Written by David Clarke|Bank of England, European Central Bank, Federal Reserve, People's Bank of China

Central banks are not yet ready to calibrate prudential policy tools such as capital requirements on the basis of climate scenario exercises, according to a new report from the Network for Greening the Financial System (NGFS).

The report, which is based on a survey of NGFS members, says central banks want more data and analysis before contemplating additional measures.

“Respondents cited various macroprudential policies that could be considered in the future, once methodological gaps are relatively more closed and the institutions improve their understanding and expertise of climate-related risks,” say the authors. “Possible measures included additional capital requirements or sectoral systemic risk buffers.”

Climate advocates have expressed their frustration with what they see as an unnecessary and unacceptable delay.

“Legislators must get out of the dead end they have put themselves in and adjust capital requirements at Pillar 1 level to reflect the risk and increase the resilience of the financial system – instead of waiting for an impossible quantification of climate-related risks as they are doing at the moment.” said Julia Symon, senior research and advocacy officer at Finance Watch.

The report will form part of the NGFS’ contribution to the Cop26 summit, which begins in Glasgow next week. It finds that central banks are increasingly using climate scenarios to identify, assess and understand climate risks in their economies and financial systems. Four have completed and published their exercises, with a further 21 due for completion in the next 12 months.

Although the authors observe that there is currently a diverse range of methodologies being used, they expect there to be an emergence of best practice over time. “Insights into the financial impacts from transition and physical risks will become increasingly comprehensive,” says the paper.

Despite this, the authors acknowledge the limitations of climate scenario exercises in understanding the need for targeted prudential policies to address climate risks. The nature of climate impacts are long term and non-linear, the evolution of climate policies is uncertain, and there is a high degree of complexity deriving from the interaction between different economic actors, the report warns.

Symon highlighted the methodological limitations of climate exercises as a reason for regulators to expedite the introduction of new rules.

“Waiting for the improvements of climate exercises which, by the NGFS’s own admission, may not be useful to understand the required prudential policies comes down to refusing to act in the face of a major threat,” she said.

This page was last updated October 22, 2021

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