Warnings of a systemic, climate-related risk to financial stability strengthen the case for prudential measures under the existing Basel framework, a leading think tank and NGO has said following last week’s publication of the IPCC’s Sixth Assessment mitigation report. Finance Watch, whose mission is to defend the public interest in the making of financial regulations, said that financial institutions are still incentivised to downplay medium-term climate risks in favour of short-term profits, potentially leaving taxpayers to pick up the tab as transition risks materialise.
The IPCC mitigation report, the third in the current assessment by global scientists, found that “rapid, deep and immediate” cuts in CO2 emissions are needed to avoid the worst impacts of global heating. Given the “magnitude of assets that are potentially exposed” and the growing potential for a “delayed and uncoordinated transition”, the study found that this represents a systemic threat to financial stability. Speaking at a press conference following the report’s release, UN secretary general Antonio Guterres was direct, warning that fossil fuel investments “will soon be stranded assets”.
“The latest IPCC report description of climate change as a systemic financial risk is a breakthrough which mandates more ambition from financial regulators and supervisors around the world,” Finance Watch secretary general Benoît Lallemand said. “It highlights how private financial institutions have an incentive to minimise the risk, in a context of moral hazard where taxpayers are likely to pick up the bill when risks materialise, as happened with the 2008 financial crisis.”
Head of research and advocacy Julia Symon also warned of underpriced risk. “Downplaying the risk is what we see happening as regulators and supervisors rely on financial institutions to develop their own internal approaches to account for climate-related financial risks,” she said.
Symon added that this is made worse by a lack of methodological expertise and a context where past data is of little help. “While supervisors remain in exploration mode to gather more data on climate risk, in particular through climate scenario analyses, banks and insurers are likely to seek formal compliance with ‘soft’ guidance as long as there are short-term profits to be made,” she said.
Finance Watch, which represents a network of 64 member organisations, has called for climate-related capital requirements to be incorporated into the Basel 3 international regulatory framework for banks, including mobilising Pillar I capital buffers against climate-related systemic risk. It also advocates a ‘one-for-one’ 1250% risk weighting to be applied to lending for new fossil fuel projects, requiring financial institutions to finance such projects from their own funds.
A one-for-one risk weighting would be similar to a proposal already made by the Basel Committee on Banking Supervision for bank holdings of cryptoassets, due to the high risks associated with these investments.
This page was last updated April 19, 2022
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