Financial institutions, from banks to insurers to asset managers, face climate-related risks that go far beyond the issue of social responsibility. One way or another—be it through natural disasters and forced migration, or decisive moves to transform energy use—they could end up facing trillions of dollars in cumulative losses.
By Graham Steele
& Gregg Gelzinis
The people who oversee America’s financial system seem to think that climate change isn’t their problem. As one official quipped in recent congressional testimony, he is “not a meteorologist or a climate scientist.” They should think again. By failing to take action, regulators are leaving the country exposed to a devastating crisis.
Financial institutions, from banks to insurers to asset managers, face climate-related risks that go far beyond the issue of social responsibility. One way or another—be it through natural disasters and forced migration, or decisive moves to transform energy use—they could end up facing trillions of dollars in cumulative losses. These could come in the form of defaulted mortgages in flooded areas, soured investments in regions that become uninhabitable, or non-performing loans to shuttered coal-fired power plants.
Worse, the financial sector is compounding the problem by supplying capital to the industries driving climate change. Over the past three years alone, the six largest US banks provided more than $700 billion in financing to the fossil-fuel industry. As of 2016, large insurers held $528 billion in such investments, including coal, oil, gas and related utilities. Even as some financial intermediaries have reduced their exposures to carbon-intensive sectors, the largest asset managers increased their holdings by 20% from 2016 to 2018, with the three biggest US asset managers among the leading holders of coal investments.
This willingness to finance carbon-intensive activities, without adequate regard for the longer-term consequences, jeopardises the goal of achieving net-zero greenhouse gas emissions. The world will never close the production gap, the disparity between energy produced by fossil fuels and clean energy, without addressing the financing gap between those respective industries. By one estimate, some $200 billion in capital must be reallocated in each of the next 40 years just to limit global warming to 2 degrees Celsius—the scenario outlined in the Paris Agreement.
Some might take comfort in the idea that losses will be spread over many decades, providing ample time to adjust. Don’t. Environmental changes and policy responses are inherently unpredictable, as is the market’s propensity to suddenly re-evaluate the prospects of entire industries. Dislocations can happen globally and at a moment’s notice—a scenario that Bank of England governor Mark Carney has called a “climate Minsky moment.” At the moment all we have are estimates, but the damage could exceed the scale and scope of the 2008 financial crisis
Financial institutions need to prepare and change their behaviour. To that end, they must accurately price the risks that they are assuming. This is where regulators come in. For example, they could include climate change in bank stress tests, and restrict payouts to shareholders if institutions lack the capital needed to survive losses. They could also directly increase capital requirements, requiring banks to have more skin in the game when making climate-intensive investments. Also, the Financial Stability Oversight Council—charged with monitoring and addressing systemic risks wherever they might appear—should be focused on mitigating climate-related risk outside the banking system.
Unfortunately, these and other powers are useless in the hands of watchdogs who lack the will to use them. The inertia of the current crop of US financial watchdogs stands in stark contrast to the International Monetary Fund and central banks in England, France and Australia, which are all waking up to the risks. So far, though, even the most ambitious proposals have focused primarily on approaches such as greater disclosure and monitoring of climate risks—the shortcomings of which are evidenced by the fact that the dirtiest industries are already largely in compliance.
Officials must act more aggressively, lest the carbon bubble keep expanding until it pops. Financial losses can cascade through the real economy and threaten the retirement funds of regular folks, many of whom may not even know that their pensions are filled with risky investments. Effective regulation can ease the transition to a clean energy economy, and protect manufacturing jobs and vulnerable communities. Dithering will leave the world exposed to a threat much greater than the human error that precipitated the last crisis. Science is not a counterparty that can be negotiated with, the planet is not a contract that can be restructured, and there is no bailout for a climate catastrophe.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners