Central banks group issues a climate risk blueprint

Central banks across the globe now have a "how-to guide" for assessing and disclosing climate risk across their own operations, as well as for the financial systems they oversee.

Released 14 December by the Network for Greening the Financial System (NGFS), the "Guide on climate-related disclosure for central banks" recognizes the material risks that climate-induced events pose to financial sector balance sheets and impose on monetary policy.

The guide walks central banks through steps they need to assess and disclose direct and indirect climate-related impacts through governance, risk management, and strategy. The guide recognizes that there is no one-size fits all approach and encourages each bank to tailor these recommendations to its financial systems.

At the same time, the guide emphasizes how important it is "for central banks to seek to lead by example and to demonstrate accountability by disclosing climate-related risks and, where relevant, opportunities in a progressively wider scope and increasing detail."

Formed at the Paris One Summit in December 2017 with just eight members, the NGFS now represents about 102 central banks and supervisors across five continents that have come together voluntarily to share best practices on climate and environmental risk management.

The guide demonstrates the NGFS' commitment to a declaration made at the UN COP26 climate summit in November to "improve the resilience of the financial system to climate-related and environmental risks, and encourage the scaling up of the financing flows needed to support the transition towards a sustainable economy."

Raise public awareness, investor confidence

Chris Varvares, IHS Markit US economics co-head, said the report is a further effort on the part of NFGS "to raise public and investor confidence that central banks are on the job."

The report specifically notes that "greater transparency in this regard could enhance public confidence that central banks are adequately addressing the economic and financial consequences of climate change and the transition to a net-zero economy," Varvares told Net-Zero Business Daily 15 December.

The NGFS members recognize that they play a key role in monitoring and controlling the risks that would threaten the stability of a country's financial system and potentially imperil the stability and sustainability of an economy.

They also are now acknowledging that the banking sector is potentially exposed to the risks posed by climate-driven severe weather events, which, for instance, have caused billions of dollars in damage to properties, businesses, and infrastructure which, in turn, has affected the portfolios of banks and other institutions.

These risks can either be felt directly through severe weather events or as indirect transition risks driven by changes in policy, advances in technology, or a combination of both.

'Warning signal' for investors

"The network of central bankers, which includes the US Federal Reserve and the People's Bank of China (PBOC), is now recommending that central banks incorporate climate risk into their core risk functions, impacting what assets they will take as collateral and how they will treat climate risk in overseeing private banks under their jurisdiction," IHS Markit Climate and Cleantech Executive Director Peter Gardett said.

For investors holding financial instruments with unclear climate risk, Gardett added the guide is "a warning signal to get their portfolio strategy in order."

As Steven Rothstein, managing director for Ceres' Accelerator for Sustainable Capital Markets, noted, "there are probably no institutions around the world that are more central to the future of the capital markets and more respected than central banks."

While not prescribing a particular approach for disclosure for central banks, the guide is essentially saying climate change can no longer be treated as side project.

Forward-looking assessments

In other words, the traditional approach of assessing risk by identifying the emissions gap between the present and future levels won't be enough to monitor and measure the full spectrum of risk.

This shortcoming in assessing climate risk also was pointed out in an April report by the Basel Commission on Banking Supervision (BCBS), the primary global standard-setting organization for central banks.

The BCBS report said central banks generally were measuring near-term risk drivers arising from policy changes in terms of bank exposure because of the uncertainty of when and where climate impacts would be felt and with what frequency.

Recognizing there is no one-size-fits all approach as all central banks operate differently, the guide presents a variety of disclosure options that central banks may follow based on their specific circumstances, such as mandates, disclosure obligations, balance sheet composition, and resources.

Citing examples of central banks that already have incorporated the direct physical risks posed by climate change into their core operations, the guide recommends central banks disclose "whether, and how, they have assessed the ability of monetary policy counterparties [banks], as well as issuers in their portfolios, to prevent, withstand, or recover from impacts of natural disasters and substantially higher average temperatures."

The guide said six banks—Bank Negara Malaysia, Bank of England, Bank of Russia, the Central Bank of Brazil, De Nederlandsche Bank (central bank of The Netherlands), and Monetary Authority of Singapore—have issued reports describing how they have incorporated climate risk disclosures into their strategies.

US, Chinese central banks

However, the guide didn't mention the steps the PBOC is taking to tackle climate risk. During the climate finance day at the UN COP26 meeting, PBOC Governor Yi Gang said China's central bank has "recently released guidelines on disclosure which asks financial institutions to disclose carbon emissions and other environmental information largely consistent with [Task Force on Climate-Related Financial Disclosure] recommendations." He said the bank also is conducting climate stress tests for its financial system based on the scenario analysis encouraged by NGFS.

It also didn't mention that the US Federal Reserve Board, which joined NGFS a year ago, plans to include climate change risk as part of its framework to assess the financial stability of banks that it oversees. And that it is in the process of developing "scenario analysis" to assess the possible risks associated with climate change to the resiliency of individual financial institutions and the financial system as a whole.

The NGFS guide does encourage central banks to include relevant analyses that identify risk under varying global warming scenarios. As part of its mandate to be transparent, the guide urged central banks to disclose any changes to operational frameworks for monetary policy, asset management, and financial stability embedded in climate-related strategies. It also encouraged central banks to report any "evaluations of their strategies' resilience to climate-related scenarios that differ from the scenarios underlying the central bank's baseline disclosure requirements."

Posted 16 December 2021 by Amena Saiyid, Senior Climate and Energy Research Analyst