Friday, February 23, 2024

Climate transmission | The financial sector is exposed to economic shocks

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Maria Gill
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Canadian financial institutions are likely to be hit by major economic shocks as the global economy continues its transition to a low-carbon world, according to a new report from the Bank of Canada and the Canadian banking regulator.

Posted at 1:24 pm

Ian Bekes
Canadian Press

The climate policy scenarios discussed in the document do not constitute forecasts or predictions, but are intended to illustrate the potential consequences of climate shift on the Canadian economy as a whole. Tony Gravel, Deputy Governor of the Bank of Canada, said the business scenario underscores the massive transformations underway.

“All scenarios showed that as we move globally towards carbon neutrality, some sectors will be significantly affected and the economy as a whole will experience significant structural changes.”

Speaking at a press conference, Gravel said the study showed that the Canadian banking and insurance sectors need to carefully plan for the ongoing transition.

For the financial sector, poor assessment of these climate risks could expose financial institutions and investors to sudden and significant losses.

Tony Gravel, Deputy Governor, Bank of Canada

According to the Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI), the initiative is the first attempt to better understand the long-term risks posed by climate change and to assess the extent to which banks and other financial institutions themselves have access to the risk model.

Mr. Gravel noted that it was clear that financial institutions and authorities were in the early stages of building capacity to better understand the risks and shifts ahead.

Ben Jolly, OSFI Deputy Superintendent, said that while many organizations are just beginning to ramp up their efforts, there is still plenty of time as the regulator aims to build resilience by the end of the decade.

“We have time, but we have no time to waste preparing for 2030.”

The report highlights that Canada is more at risk of facing the economic effects of the transition due to its greater exposure to commodities, which will lead to lower prices while promoting climate policies globally.

The scenarios show that faster action on climate change will lead to a smoother and less dangerous transition. In contrast, modeling of sudden shifts in global politics showed potential turmoil in financial markets, accompanied by a 10% decline in Canada’s GDP from what it would be by 2050 in the baseline scenario.

The pilot study found that fossil fuel sectors were particularly vulnerable, although other sectors, including agriculture and livestock, would also be affected, and the electricity sector would be strengthened.

A scenario aiming for an immediate shift to policies needed to keep warming to 2°C found that refined oil producers would see a 72% decrease in net income by 2050 and a 450% increase in default probability compared to the reference scenario. The agriculture sector could see a 32% decrease in net income and a 141% increase in default.

The scenarios, which look to a 30-year horizon, make many assumptions and do not take into account many key factors such as the physical risks of climate change and how certain technological innovations could alter trajectories.

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The report, produced in collaboration with six financial institutions, found that modeling can require more effort than expected and is still hampered by unequal access to data.

Mr Jolly said that although it is a new effort, the pilot has been a success, as it raises awareness of the risks and strives to better understand their implications.

“Climate scenario analysis exercises like this clearly demonstrate the potential financial implications of climate transition risks under different transition paths.”

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