Enhancing Climate Risk Perspective in a New Mindset to Transform Supervisory and Market Approaches
IMF News, June 1, 2022
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- Published: June 1, 2022
Context and overarching message
- Opening Remarks by Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department, IMF.
- Delivered at the Joint FED-IMF-WB 21st Annual International Conference on Policy Challenges for the Financial Sector.
- Date: June 1, 2022.
- Conference context: heightened geopolitical, economic, and financial uncertainty following the pandemic and the breakout of the war in Ukraine, producing tighter global financial conditions, increased uncertainty, and fresh financial market volatility.
Key risks identified
- Rising risks to the inflation outlook and rapidly changing views about the likely pace of monetary policy tightening are dominant factors impinging on financial stability.
- The sharp rise in commodity prices and supply disruptions have led to a significant increase in inflation expectations.
- Trade-offs for central banks: fighting record-high inflation versus safeguarding the post-pandemic recovery amid heightened global uncertainty.
- Potential for an unanticipated intensification of the war and escalation of sanctions to trigger a sudden repricing of risk and sharp decline in asset prices.
- Potential transmission channels of the war in Ukraine on global financial markets:
- direct and indirect exposures of banks and nonbanks;
- market disruptions in commodity markets and increased counterparty risk;
- poor market liquidity and funding strains;
- acceleration of cryptoization in emerging markets;
- possible cyber-attacks.
- Banks’ direct exposures to Russia appear small, but indirect exposures are more difficult to identify and may surprise investors.
- Emerging and developing economies face tighter financial conditions and higher risks of capital outflows due to monetary policy normalization and heightened geopolitical uncertainty.
- Emerging market sovereigns have become more reliant on domestic banks for funding; bank holdings of domestic sovereign debt have surged to historic highs.
- Risk of an adverse feedback loop between sovereigns and banks that could reduce bank soundness and lending.
- Technological innovation (fintech) can support inclusive growth but rapid growth of risky segments under little or no regulation can raise financial stability concerns.
- The war has clarified urgency of transitioning away from carbon-intensive energy, but the ongoing energy crisis may delay phasing out fossil fuel subsidies in emerging market and developing economies — geopolitics of energy security may put climate transition at risk.
Monetary policy and macroprudential recommendations
- Central banks should act decisively to address financial vulnerabilities and rein in rising inflation.
- Advanced-economy central banks should provide clear guidance about the normalization process while remaining data dependent to avoid unnecessary volatility.
- Emerging markets should manage the delicate balance between containing inflation and supporting the pandemic recovery.
- Policymakers should consider tightening certain macroprudential tools to help balance containing buildup of vulnerabilities and avoiding procyclicality.
Financial technology and payments system priorities
- Policymakers should develop a comprehensive, consistent, and coordinated global approach to regulation and supervision of crypto assets.
- On Central Bank Digital Currency (CBDC), emphasize cross-border aspects and interoperability to avoid fragmentation in payment systems.
- A stable and open international payments system is a vital pillar of the international monetary system.
Climate risk: priorities and specific measures
- Policymakers should intensify efforts to implement the 2021 United Nations Climate Change Conference (COP26) road map to achieve net-zero targets notwithstanding short-term setbacks from the war.
- Important areas to advance:
- Take measures to increase the availability, and lower the cost, of fossil fuel alternatives and renewables and to improve energy efficiency.
- Scale up private climate finance to remove a major barrier to mitigation.
- Cited IPCC finding: annual climate finance flows need to increase by 4 to 8 times in developing countries by 2030 and long-term private capital is needed to close this financing gap.
- Strengthen the global climate information architecture in terms of disclosure standards, classification approaches and bridging data gaps.
- Note: progress by the ISSB on disclosure is welcomed; transparency needs to be mandated to support scaling up climate finance and monitoring of climate risks.
- Adequate classification provides investors easy-to-interpret information; globally agreed principles for classification would facilitate effective global climate change mitigation.
- Incorporate climate risk into prudential supervisory and regulatory frameworks in a proportionate way that reflects characteristics of countries’ economies and financial systems and potential climate risk exposure.
- International efforts referenced: guidance for supervisors by the Network for Greening the Financial System (NGFS); ongoing Basel Committee work to define detailed, comprehensive and evidence-based international guidance on prudential supervision.
IMF role, activities, and capacity building
- The IMF is actively contributing through knowledge of global financial stability challenges and of climate risk and supervisory issues across its membership to help ensure wide applicability of regulations.
- Examples of IMF activities:
- Technical assistance activities initiated, including a series of regional webinars introduced last year.
- Registering first requests for bilateral technical assistance and deepening dialogue on the topic within FSAPs.
Closing assessment
- Despite multiple challenges, strong foundations exist globally to ramp up capacities to tackle pressing issues and strengthen financial systems long term.
- Conferences and high-level discussions materially add to these foundations and contribute to solutions.
Opening Remarks by Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department, IMF — June 1, 2022.