A trillion dollar climate risk

The globe’s largest financial institutions hold over $1.6 trillion in credit risks related to coal, oil, natural gas production, and fossil-fuel power generation, as reported in a new analysis from Finance Watch.

The findings suggest a feasible solution with minimal financial impact. A climate systemic risk buffer could provide banks with an essential safety net against potential losses from fossil fuels, reducing the buildup of climate-related risks, and safeguarding the financial system as well as taxpayers from potential crises.

According to Finance Watch, the implementation of such a buffer would be relatively straightforward for EU banks, which would only need to set aside a few weeks’ worth of profits to support this additional capital requirement. This measure could be enacted without hindering banks’ capacity to lend to the broader economy.

Mispricing

Julia Symon, Head of Research and Advocacy at Finance Watch, stated, “Banks currently have over a trillion dollars tied up in mispriced fossil fuel assets.”

“This represents a carbon bubble that could potentially burst, reminiscent of the subprime crisis in 2008. This risk is not being adequately acknowledged, and banks are unprepared. Their risk assessment models are either retrospectively focused or depend on forecasted climate scenarios that overlook the intricate realities of climate change.”

“This oversight allows risk to accumulate. A sudden policy change or significant climate incident could provoke abrupt market reactions, resulting in plummeting fossil asset prices.”

She further noted, “What’s more concerning is that the mispricing of fossil fuel loans perpetuates financial backing for the sector, exacerbating the climate crisis and amplifying risks throughout the financial system.”

Transition

Greg Ford, the report’s author and a Senior Advisor at Finance Watch, remarked, “There exists a significant prudential gap that permits climate-related systemic risks at banks to remain unregulated.”

“Our analysis indicates that a climate systemic risk buffer would be a cost-effective and beneficial approach to mitigate these risks and enhance the resilience of banks. Importantly, this could be rolled out without impacting the lending capabilities of EU banks.”

“Policymakers must address the trillion dollars of mispriced climate risks on bank balance sheets. Delaying action only increases the likelihood of a chaotic adjustment that will adversely affect citizens and the wider economy.”

Recently, the European Central Bank cautioned that “a haphazard transition to a green economy may result in substantial losses for banks concerning their high-emission firm exposures.” Nevertheless, existing data demonstrates that climate risks are not being adequately integrated into banks’ internal risk models.

This Author

Brendan Montague is part of the editorial team at The Ecologist. This article is based on a press release from Finance Watch.