Recently, Deputy Governor of the People’s Bank of China (China’s central bank) gave a speech at the Annual Meeting of the China Society for Finance and Banking, titled “Climate Change Poses Risks to Macro-financial Stability”, stating for the first time that the PBOC would focus on climate-related financial risk analysis.
Here is part of the translated script:
Climate change has become a major factor leading to structural changes in the economy and financial system. Given its long-term, structural and far-reaching impact, it has raised increasing attention from central banks around the world.
Firstly, climate change may lead to declining values of collaterals and the tightening of credit conditions. With the financial accelerator mechanism and the collateral constraints, the severity of climate change risks may be amplified by the market. As a result, any shocks on one single financial institution may turn into systemic risks. Secondly, climate change is irreversible with a high degree of uncertainty, but financial institutions may only look at the average expected losses from climate change and are not prepared for more extreme situations. Thirdly, climate change has feedback-loop and spill-over effects on the financial system and the economy. Adverse climate impact may cause credit conditions to tighten, further weaken the balance sheets of households and businesses and affect potential economic growth and output gap. Therefore, central banks should have sufficient foresight in effectively managing shocks from climate change. Strengthening environmental risk analysis is an important part of the effort establishing a modern financial system and an effective macroeconomic policy framework.
Since the passing of the United Nations Framework Convention on Climate Change (UNFCCC) in 1992, the UN Conference of Parties (COP) has focused on the transfer of funds from industrialised countries to developing nations. After the failure of the Copenhagen Summit in 2009, the role of the financial sector in green development has become the focal point and a leading new concept in the global finance industry. The signing of the Paris Agreement in 2015 marked another milestone for global effort to address climate-related financial risks. In April 2016, France asked the Financial Stability Board (FSB) to study the impact of global warming on financial development. In December 2017, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) was initiated by Banque de France. To date, the NGFS has expanded to 54 members and 12 observers, with the People’s Bank of China (PBC) being one of the founding members. International organizations, such as the International Monetary Fund (IMF) and the Bank for International Settlement (BIS), also began to study climate change-related financial issues. For example, the IMF made climate change one of the key topics at its annual meeting in October 2019. The latest Global Financial Stability Report (GFSR) also discussed the impacts of climate change on financial stability.
Financial risks from climate change include physical risks and transition risks. Physical risks are mainly financial risks associated with the failure of mitigating climate change, while transition risks are risks of mismatch between financial systems and the mitigation and adaptation measures taken by public and private sectors in response to climate change. These two types of risks may significantly impact macroeconomic and financial variables through a number of channels, including asset revaluation, balance sheets, changes in collaterals valuation, risk exposures, policy uncertainties and shifting market expectations, thus deliver shocks to financial stability and the macro economy.
The study of climate-related financial risks is a frontier research area. In recent years, the PBC has closely studied financial risks arising from climate change while pursuing a new model of development and a green financial system. On the one hand, the PBC is pushing for establishing a green financial standard system, and drawing experience and lessons of the programs on green finance innovations and reform in six pilot zones, so as to improve the sustainability of green finance projects and the adaption of financial system . On the other hand, the PBC has already completed an in-depth study on the transmission of stress from carbon price to businesses and banks. In Shanxi Province, the PBC assessed the impact of climate change on the financial performance of companies and related financial risks in three major industries: coal, metallurgy and coal-fired power plants.
In the next step, the PBC will focus on three issues in this area: (1) the heterogenous effects of climate change on the segments of the financial industry and respective policy response; (2) the impact of climate change on micro and macro-prudential regulations and their transmission mechanism; (3) the feasibility and pathway of incorporating climate change factors into our two-pillar macro-management framework underpinned by monetary policy and macro-prudential policy.