Speech

Climate Risks and Financial Stability: What Can Central Banks and Financial Sector Supervisors Do?

December 12, 2023

Good morning and welcome again to the seminar on climate change issues and thank you all for participating. I would like to thank the Bank of Thailand for co-hosting this seminar, and the CDOT director, Eteri Kvintradze, and SARTTAC director, David Cowen, and their staff for organizing the seminar.

This event comes at a perfect time to discuss policies that could address challenges in unlocking the necessary private climate finance in emerging market and developing economies, also known as EMDEs. As the world’s most populous continent, Asia is in a unique position. On the one hand, there are potential economic gains offered by tapping the tremendous human capital Asian countries boast. However, on the other hand, larger numbers of people face the hazards brought on by climate change. In recent years, the region has been the engine of global growth, and must now strike a balance between maintaining growth levels, managing climate risks, and contributing to global climate goals by moving to a low-carbon economy. This will necessarily involve building adaptive capacity through investments in resilient infrastructure, early warning systems, and targeted social safety nets. 

Adaptation and mitigation will require an unprecedented and massive scaling up of investments. In EMDEs, which currently emit around two-thirds of greenhouse gases, achieving the transition to net-zero emissions by 2050 means about $2 trillion will be needed annually by 2030, according to the International Energy Agency. Despite the recent growth of climate finance, the region falls short of the target as we showed in our 2022 Global Financial Stability Report and our newly launched departmental paper. The private sector will have to cover a major share of the large climate mitigation investment needs in EMDEs given severely stretched public sector budgets.

Large emerging economies are generally better placed to access climate finance; many smaller EMDEs face significant challenges in attracting private finance for mitigation and adaptation. Some of these challenges are related to low credit ratings, which limit the potential investor base. Moreover, climate policies of major banks and insurance companies are not yet aligned with net-zero emission targets. And despite the growth in sustainable investment funds, only a small share of the invested money is dedicated to creating a positive climate impact. As we show in our latest Global Financial Stability Report, the majority of funds that make investment decisions based on environmental, social, and corporate governance factors don’t necessarily focus on climate issues. In line with what we heard in the previous session, the recent survey of government officials from Asia-Pacific countries suggests three additional challenges: (i) persistent large gaps in climate data and disclosures that hinder reporting and analysis; (ii) conflicting national policy approaches—such as introducing carbon taxes amid widespread subsidization of fossil fuels; and (iii) increasing geo-economic fragmentation, which might jeopardize collective action on climate change.

In my view, a broad mix of policies is needed to create an attractive environment for private climate mitigation finance in EMDEs.

• Carbon pricing can provide an important pricing signal for investors, but it faces political hurdles in its implementation.
• Policies aimed at strengthening macroeconomic fundamentals, deepening capital markets, and improving governance will help improve credit ratings, mobilize domestic financial resources, and lower the cost of capital. Expanded use of guarantees by multilateral development banks and donors could be an effective instrument to reduce real and perceived risks in EMDEs.
• A strong climate information architecture is also a vital part of the policy mix. For instance, more-comprehensive transition taxonomies would help support the growth of sustainable markets and the production of climate data that is useful for financial decision-making, as well as climate risk assessment, regulation, and supervision. In a report released in partnership with the World Bank and the OECD, the IMF identifies common principles and technical considerations to link national climate plans and alignment strategies. In this regard, international disclosure and data initiatives like those of the International Sustainability Standards Board, the Network for Greening the Financial System and the Financial Stability Board are crucial.
• Innovative financing solutions such as blended finance and securitization instruments should be employed as part of the policy mix to broaden the range of private-sector investors.
• In low-income countries, additional international support will be needed. The IMF’s Resilience and Sustainability Facility, by supporting reforms, can help create an enabling investment environment and attract private capital.

Last but certainly not least: central banks and financial sector supervisors, as the gatekeepers of financial sector stability, should also be considered as part of the policy mix. This is the topic of our discussion in this session. Let me offer my views on two important tasks of central banks and financial sector supervisors as a background for the discussion.

• Preserving financial stability is the core mandate of financial supervisory authorities. It is important to emphasize that while supervisors should play an active role in climate-risk supervision, all the initiatives should be consistent with the core mandate of financial stability. Prudential regulation and supervision should not be used as substitutes for effective government policy on climate. Specifically, supervisors should ensure that climate-related risks are adequately analyzed and captured in their supervisory processes. Take, for instance, physical risks, such as more frequent and severe natural hazards, or risks of stranded assets in the transition to a low-carbon economy. These must be integrated into risk assessments and prudential frameworks to ensure that financial institutions are well-equipped to withstand climate-related shocks.
• To help accurately measure risks, central banks and financial sector supervisors need to build capacity to adapt their stress-testing frameworks. In particular, these frameworks should incorporate the channels through which climate risks amplify and transmit risks to the financial sector. In Asia, climate risk analyses and climate stress-testing exercises are still in the early stages of development. However, some jurisdictions in the region, have conducted top-down or bottom-up climate stress tests.
• Here, identifying and closing data gaps is key. Our experience from the Financial Sector Assessment Program, as well as from our technical assistance work, shows that lack of relevant climate data is common across jurisdictions. Financial sector experts and climate experts need to collaborate to address these climate data gaps. More specifically, efforts are needed to build comprehensive datasets related to physical risk projections and granular exposure data of the financial sector to both physical and transition risk. These datasets will be also a valuable tool for analyzing cross-border risks for banks with an international footprint.
• Central banks and financial supervisors should incorporate climate-related financial risks into the prudential framework. Where possible, the Basel Committee on Banking Supervision Principles for the Effective Management and Supervision of Climate-related Financial Risks should be implemented by supervisors through adapted guidance and monitoring. This should consider the specific risk profile of each jurisdiction regarding the impact of climate change, as well as the principle of proportionality. Bridging data gaps for supervisory reporting and financial disclosure is a pre-condition for effective supervision of climate-related financial risks. Earlier this year, the International Sustainability Standards Board issued international standards on climate-related disclosure. But supervisory reporting should be tailored to each jurisdiction, depending on the risk profile and supervisory needs. For instance, in a number of jurisdictions, non-life insurers are at the front line of exposure to physical risks, and supervisors there should focus on how non-life insurers are managing such risks. Here in Asia, supervisors are in different stages of climate supervision. Some have already taken advanced initiatives while others are in the exploratory phase. And in this session, we will have an opportunity to hear practical experience from our distinguished panel.
• On our side, through our Financial Sector Assessment Program and our capacity development work, delivered in part by regional centers, the IMF provides guidance to central banks and financial sector regulators on how to conduct climate risk analysis and adjust their frameworks in line with the Basel Committee’s Principles. We are also collaborating with the Interagency Group on Economic and Financial Statistics, the European Space Agency, the World Bank, and the Network for Greening the Financial System to tackle climate data gaps.

To conclude, although Asian countries currently face a number of important challenges, including on climate finance, they need to tackle the adverse impact of climate change. Central banks and financial sector supervisors can contribute to this goal in three main ways. First, by closing climate-related data gaps and strengthening climate-related financial disclosures; second, by incorporating the reporting of climate risks into the supervisory processes; and third, by enhancing their capacity to conduct climate risk analyses. I am delighted this conference will provide a platform for us to advance our thinking in this area. And for this session we have deputy governors from Bangladesh, Brunei Darussalam, Cambodia, Maldives, and Philippines, who will provide practical insights into the challenges they face in ensuring financial stability in the era of climate change. I look forward to the roundtable discussion.