The Green Swan Toolkit: Four Priorities to Ensure Financial Stability in the Age of Climate Change

This policy briefing from a collaboration of leading civil society groups synthesises research on climate-related risks to offer four key policy proposals. These are directed to central bankers attending the Green Swan Conference in June 2021.

Eight major organisations working at the intersection of climate change and finance argue for a precautionary response to climate change, one that goes beyond risk disclosure to incorporate risk mitigation. They also call for changes in the Basel Accords to include and reduce the systemic dangers from climate change and the transition to a net-zero world.

The proposals outlined in the brief aim ensure financial stability in the age of climate change:

1. A precautionary approach

Financial regulators should adopt a precautionary approach to climate risk that goes beyond disclosures, scenario analysis and stress testing, the paper argues. While this work is valuable, the radical uncertainty of climate risk makes efficient price discovery impossible, while continuing the bias towards avoiding short-term market disruption at the expense of longer-term, potentially catastrophic and irreversible, climate risks. Instead, the authors propose an alternative and “precautionary” financial policy approach which factors in longer-term risks to avoid the buildup of unaccounted climate risks in the financial system.

2. Adapting Pillar 1 capital requirements to take into account the financial risks caused by fossil fuel exposures

Pillar I capital requirements of the Basel Accords should be adapted to incorporate the financial risks caused by fossil fuel exposures. Under the Basel Accords which regulate global banking, Pillar I sets out rules to define capital requirements to account for credit, operational and market risk. Given the high risk of fossil fuel companies’ assets becoming stranded, exposures to these assets should be treated in the same way as exposure to other risks.

3. Addressing systemic risk from climate change

Financial supervisors should also consider the systemic risk from climate change, warning of sharp falls in asset prices amplified by financial markets. These systemic risks should be reflected in macroprudential frameworks by implementing systemic risk buffers to mitigate them. Once again, the Basel Framework provides financial regulators with such buffers, already widely used to mitigate cyclical, concentration, contagion and other macroeconomic systemic risks.

4. Requiring the inclusion of climate criteria in financial decision-making

Finally, financial regulators should require banks to integrate climate criteria into their financing decisions. This would be done by setting regulatory expectations for the Basel Pillar II requirements which set the rules for supervisory review. These expectations should include Paris-aligned climate targets, five-year transition plans and a mechanism to integrate climate criteria into financing decisions.

The Green Swan Toolkit is a combined proposal from Reclaim Finance, Positive Money, Climate Safe Lending Network, New Economics Foundation, Re:Common, Greenpeace, BankTrack and Public Citizen.