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Central banks urged to study nature-economy tipping points

February 1, 2023|Written by David Clarke|Bank of Japan, European Central Bank

The importance of nature-economy tipping points is highlighted in a new report, the World Bank considers the impact of climate capital measures, and more from this week in green central banking.

Nature-related risk assessments must consider tipping points

Academics at the LSE Grantham Institute say that methodologies for assessing nature-related risks to the financial system must include the possibility of tipping points caused by interactions between the biophysical environment and economic activity.

A new paper examines models and scenarios currently in use, and identifies some key criteria that methodologies should satisfy if they are to provide useful guidance for the financial sector in assessing nature-related risks.

None of the models reviewed as part of the study are able to capture both non-linearities and endogenous tipping points. This refers to changes which are self-perpetuating and do not have a simple cause and effect.

An example of a nature-economy tipping point is that degradation of agricultural land could cause that land to become less fertile, meaning it no longer meets the necessary conditions for crop production. The ability of the ecosystem to support economic activity would be persistently disrupted.

The paper also recommends that central banks and financial institutions use a wider range of models, including ones with different assumptions, in order to improve their understanding of nature-related risks and impacts.

Take system-wide view when implementing climate capital measures, says World Bank

Climate-related prudential measures must be carefully calibrated in order to avoid migrating risks to smaller lenders and undermining financial inclusion, economists at the World Bank have warned.

Their caution follows a study that evaluated the effects of a 2017 policy introduced in Brazil requiring systemically important banks to incorporate environmental risks into their capital adequacy assessments. According to the study, the policy led to sharp contraction of credit to polluting sectors by large banks. But at the same time, smaller banks also experienced a noticeable increase in exposure to the same sectors.

“This highlights the importance of safeguarding the entire financial system when implementing climate-related prudential measures,” the authors argue.

The study also found that, while many firms were insulated from the effects of the measure as they could substitute credit across lenders, climate-related capital requirements may disproportionately affect borrowers who are less able to shop around.

BoJ conducts new climate loans auction

The Bank of Japan (BoJ) has conducted another auction in its climate loans scheme. Loans totalling 2.8tn yen were made available to banks in the country, in the largest disbursement in the facility so far.

The initiative was launched last year and provides zero-interest financing to lenders supporting action to address climate change.

Governor Haruhiko Kuroda said earlier this month that the BoJ is required by law to cooperate with the government in guiding monetary policy, an approach that also applies to dealing with sustainability concerns.

He said that while the BoJ does not have a specific climate mandate, its measures taken in relation to climate change are in line with those of the government and “generally accepted by the public”.

This page was last updated February 21, 2023

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