1、June 2020 Breaking the climate-finance doom loop How banking prudential regulation can tackle the link between climate change and financial instability A Finance Watch report “Faced with sets of events that are complex, subject to radical uncertainty but with the likelihood of a massive future impac

2、t, Green Swans call less for improvements in risk modelling and more for decisive and immediate action and coordination” Luiz Awazu Pereira da Silva Deputy General Manager of the Bank for International Settlement Author: Thierry Philipponnat Contributors: Benot Lallemand, Paul Fox Editor: Greg Ford

3、Photo credit: Cover photo by Igor, Adobe Stock Typesetting by Mathilde Philipponnat Finance Watch 2020 The contents of this report may be freely used or reproduced without permission provided the original meaning and context are not altered in any way. Where third party copyright has been acknowledg

4、ed, permission must be sought from the third party directly. For enquiries relating to this report, please email contactfinance-watch.org Finance Watch has received funding from the European Union to implement its work programme. There is no implied endorsement by the EU or the European Commission o

5、f Finance Watchs work, which remains the sole responsibility of Finance Watch. Table of contents Executive summary 4 Recommendations 6 Introduction: A curious combination of certainty and uncertainty 8 Chapter 1: Introducing the climate-finance doom loop 10 I. It all starts with human-induced global

6、 warming 10 II. The role of finance in the acceleration towards climate disaster 11 III. Dynamics of the climate-finance doom loop 14 Chapter 2: What financial regulators and supervisors are doing.and not doing. 17 I. A broad recognition of the impact of climate change on financial stability 17 II.

7、Climate stress tests and their limitations 19 III. Forget about stress tests, long live scenario-based analyses 22 Chapter 3: Prudential regulation as a tool to tackle climate-related financial instability 24 I. Regulation as the only way to promote the public interest 24 II. Prudential regulation a

8、s a tool to combat climate-related financial instability 25 III. A three-step logic to the action EU policy-makers must take 27 Chapter 4: Thinking economically about breaking the climate-finance doom loop 29 I. Identifying banking practices enabling the acceleration of climate change 29 II. Making

9、a distinction between existing and new fossil fuel reserves 29 III. Fixing a risk weight for existing fossil fuel exposures 31 IV. Fixing a risk weight for new fossil fuel exposures 32 Chapter 5: What regulatory tools to tackle the climate-finance doom loop? 34 I. Acting without waiting: EU-wide vs.

10、 national measures 34 1. EU-wide measures: activating Article 459 CRR 34 2. Why national measures are less suitable: Articles 458 CRR and 133 CRD4 35 II. Reforming CRR2 as a permanent solution: Articles 128 and 501 CRR2 37 Conclusion 39 Bibliography 41 Breaking the climate-finance doom loop Finance

11、Watch Report | June 20204 Executive summary Tackling financial instability induced by climate change Urgent action is needed to tackle the climate-finance doom loop, in which fossil fuel finance enables climate change, and climate change threatens financial stability. Action by regulators and superv

12、isors so far has not been able to break this dynamic, partly because of the difficul- ty of modelling the risks that climate change poses to financial stability. This report argues that risk modelling is not a prerequisite for tackling the climate-finance doom loop and that regulators already have t

13、he economic understanding of the situation, the legal basis and the regulatory tools needed to intervene immediately. The global carbon budget will be exhausted within 10-15 years. All new fossil fuel production and a significant part of production out of existing reserves are incompatible with Pari

14、s goals to limit global warming to 1.5C. Banks are an important source of funding for this production, witness the $2.7 trillion provided to the oil and gas industry in the four years after the Paris Agreement. The climate-related disclosure framework emerging from EU sustainable finance regulation

15、captures the two-way nature of the climate-finance doom loop, where finance both enables devastating climate change and will itself be devastated by climate change. But transparency measures cannot reduce on their own the macro-prudential risks that fossil fuel financing causes by enabling climate c

16、hange, if an- ything because private agents are not responsible for the public interest. Financial regulators and supervisors have come far in recognising the threat climate change represents for financial stability. But their actions so far, useful as they are, have been focused mainly on transpar-

17、 ency measures and stress tests. In the best of cases, more effective prudential interventions will take years to enter into force, by when the planets carbon budget will be nearly exhausted. Climate stress tests are effectively scenario-based analyses looking at how financial institutions will fare

18、 in different climate change scenarios, but they do not derive conclusions regarding the solvency of institutions. Incidentally, they seek to assess transition risk and, for some of them, physical risk but not the risk of disruption as businesses, finance and insurance providers will respond to adve

19、rse new con- ditions. These second-round effects can be large, unpredictable and non-linear, as the Covid-19 crisis has shown, and are almost impossible to model. The lack of prudential action so far is grounded in a paradox: policy-makers recognise the near-impos- sibility of modelling climate-rela

20、ted risks but say that they need such modelling to be done before inter- vening. Unfortunately, given the short time available, late action is equivalent to doing nothing. Climate change will have a significant impact on financial stability. Policy-makers should act now using tools already available

21、 rather than waiting to assess unquantifiable risks before acting. As a number of central bankers have noted, the situation calls for less modelling and more decisive and immediate action and coordination. In this context, the EU must take preventive action as it is bound to do under the Treaty on t

22、he Func- tioning of the European Union, which establishes the precautionary principle as one of its governing principles. The most suitable tool to do so is prudential measures targeted at banks with assets at risk of being stranded and that contribute to climate-related macro-prudential risk. The E

23、Us Capital Requirements Regulation (CRR) is designed to prevent financial instability and provides, among other things, for higher Breaking the climate-finance doom loop Finance Watch Report | June 20205 risk weightings in situations where the risk of loss cannot be measured precisely even if its oc

24、currence is certain. Applying higher risk weights to existing exposures to fossil fuel assets, which are at risk of stranding, would be consistent with the approach taken in Article 128 of CRR2 of applying 150% risk weights to exposures associated with risks that are particularly high or difficult t

25、o assess. New fossil fuel exposures, on the other hand, create a macro-prudential risk by accelerating climate change and a larger micro-prudential risk of becoming stranded. Article 501 of CRR2 could be adapted through a risk weight chosen qualitatively, rather than attempting to measure the unquan

26、tifiable mac- ro-prudential risks resulting from climate change. Applying a risk weight of 1250% to new fossil fuel exposures under the standardised approach with a similar floor for internal models would make these activities entirely equity-funded, an appropriate treatment for assets with the micr

27、o- and macro-pruden- tial characteristics described above. Given the time needed to amend legislation, the European Commission should immediately activate Article 459 of CRR to apply these risk weights until they have been inscribed in Articles 128 and 501 of CRR2, as part of the 2020 review of the

28、Banking Package agreed in December 2018. Given the global nature of the problem, the actions suggested to EU policy-makers in this report also need to be presented for use in other jurisdictions via the Basel Committee for Banking Supervision (BCBS) and the Financial Stability Board (FSB). Our recom

29、mendations to target the doom loop between climate change and financial stability are far less radical and much cheaper than the actions taken in response to the Covid-19 crisis, but they target a far bigger threat for which policy-makers are already empowered and equipped to act. Breaking the clima

30、te-finance doom loop Finance Watch Report | June 20206 Recommendations Why The world is on a path of accelerated human-induced climate change linked to greenhouse gas emis- sions, and central bankers all over the world agree on the fact that climate change represents a major threat to financial stab

31、ility. As the main provider of finance to the fossil fuel industry, bank lending is the de facto enabler of global warming. Given the destabilising effect that climate change will have on the financial system, the situation is therefore one of a doom-loop where finance has become the enabler of a ph

32、e- nomenon that will end-up destroying it. Regulators, supervisors and central bankers have undertaken an important workstream to better un- derstand and evaluate the impact of climate change on the financial system. However, regardless of the importance and the relevance of this push, policy-makers

33、 should be aware of the fact that it will not be sufficient on its own to tackle the issue. In that context, Article 191 of the Treaty on the Function- ing of the European Union (TFEU) sets out the Unions policy on the precautionary principle and refers explicitly to the duty of combatting climate c

34、hange, requiring EU policy-makers to take preventive action in the case of risk. The recommendations of this report address the financial stability implications of banks lending activity to the fossil fuel industry. They aim to tackle both the macro-prudential and the micro-prudential risks induced

35、by the situation. As such, they bring a solution to EU policy-makers to take the action they need to take under Article 191 TFEU. 1 2 3 What Calibrate the risk weight for bank exposures to existing fossil fuel reserves at 150% in order to make it coherent with Article 128 of the Capital Requirements

36、 Regulation (CRR) (page 31) Calibrate the risk weight for bank exposures to new fossil fuel reserves at 1250% in order to make the financing of new fossil fuel exposures by banks entirely equity-financed to reflect both micro-prudential and macro-prudential risks (page 32) Ensure that the modified r

37、isk weights are reflected in banks internal models for the purpose of calculating capital requirements (pages 32 and 33) Breaking the climate-finance doom loop Finance Watch Report | June 20207 4 5 6 How The European Commission should use without delay the power given by Article 459 of CRR to take a

38、ction by issuing delegated acts “to impose, for a period of one year, stricter pruden- tial requirements for exposures where this is necessary to address changes in the intensity of micro-prudential and macro-prudential risks”. In the current context of obvious change in the intensity of micro-prude

39、ntial and macro-prudential risks, activating Article 459 would allow the European Commission to take immediate action and implement the modified risk weights until banks prudential requirements for fossil fuel exposures have been amended in CRR (pages 34 et 35) Amend the risk weights for banks exist

40、ing fossil fuel exposures in Article 128 of CRR and for banks new fossil fuel exposures in Article 501 of CRR (page 37) Promote the adoption of similar prudential requirements globally by engaging the Basel Com- mittee on Banking Supervision (BCBS) and the Financial Stability Board (FSB) (page 40) B

41、reaking the climate-finance doom loop Finance Watch Report | June 20208 Introduction A curious combination of certainty and uncertainty The impact of climate change on economic and financial systems is somewhat of a paradox in the way it combines certainty and uncertainty. Four things are certain ab

42、out the impact of climate change on economic and financial systems: 1. Climate change is happening, it is directly linked to human-induced greenhouse gas (GHG) emis- sions, and humanity can only continue to emit GHG at the present rhythm for a period comprised between 10 and 15 years before it becom

43、es too late to keep global warming “well below” 2C, as targeted by the 2015 Paris climate agreement. 2. Once global temperatures have risen above 2C relative to pre-industrial levels, we will enter un- chartered territory, with enormous and unpredictable negative consequences on human societies and

44、the global economy1 building up during the following decades. 3. Finance, by its very nature, is an enabling factor of anthropogenic climate change: by allocating capital to fossil fuel exploration, production and exploitation, finance is the principal vector enabling global warming. Finance itself

45、does not create global warming, but it makes it possible. 4. Given the consequences that climate change will have on the economy, it is now widely recognised by central bankers that climate change represents a most significant risk to financial stability2 to the extent that it could threaten the ent

46、ire financial system. If the direction of travel of climate change is considered today as certain by the scientific community and by rigorous observers, measuring its impact on the economy and on the financial system is, how- ever, considered in the best of cases as “uncertain” or “challenging” by s

47、ome,3 and as “impossible” by many others.4 When it comes to climate change, we are not able to give answers to simply formulated and essential questions: how can we quantify the impact of climate change on the economy and on the financial system? Can we evaluate precisely the so often-discussed tran

48、sition risk and physical risk incurred by financial institutions due to climate change? Do we understand how the interconnection of financial institutions will contribute to spreading climate-related financial risk? How do we take into ac- count second or third round effects on the economy when it c

49、omes to quantifying the impact of climate change? When will the tipping point happen? Let us make a long story short: for all the science that mankind can pour into quantifying the impact of climate change on economic and financial systems, we will never be able to measure it with the level of confidence that decision-makers like to have to take action. The reason for this is simple to understand: we are not dealing with risk but with uncertainty. Evaluating risk in general, and financial risk in particular, 1 See, for instance, Intergovernmental Panel