Threat from climate change to financial stability bigger than Covid-19

Climate change poses a bigger threat to financial stability than the coronavirus pandemic and the rules on bank lending to fossil fuel groups must be tightened to address it, a new report has warned. In his latest research for the Finance Watch advocacy body, Thierry Philipponnat — a board member at the French financial regulator, and one of the EU’s technical experts on sustainable finance — has recommended increasing the risk weightings banks must apply to their oil, gas and coal exposures. This would make them treat fossil fuel lending in the same way as other risky investments, increasing their capital requirements to insulate them against possible losses. 

Banks would therefore have more protection against the risk of carbon assets becoming “stranded” if demand falls — or the risk of costly climate disruption if it does not. According to Mr Philipponnat, only this regulatory approach can end the “climate-finance doom loop”, in which fossil fuel finance enables climate change, and climate change threatens financial stability, through disruptive natural events. Finance Watch estimates that climate-related risks to the financial system are greater than those posed by pandemics, such as coronavirus. “The actions we are proposing today are far less radical or costly than those taken in response to the Covid-19 crisis but they target a far bigger threat,” said its secretary-general Benoît Lallemand. “They address a disruption risk of another order of magnitude.” 

Under the report’s proposals, the risk weighting for bank exposures to existing fossil fuel reserves would be increased from 100 per cent to 150 per cent, making banks treat them the same as risky venture capital and private equity lending, for capital purposes. And the risk weighting for bank exposures to new fossil fuel reserves would be increased from 100 per cent to 1,250 per cent, making equity finance the only option, and one that better reflects the future threats. In recent years, climate change campaigners have been calling on banks to reassess their financing of fossil fuels to help meet the goal of the intergovernmental Paris Agreement: limiting the global temperature rise to 1.5C over the pre-industrial average. 

However, last year, an analysis by Rainforest Action Network found that 33 banks provided $654bn to 1,800 fossil fuel companies, equivalent to 70 per cent of the capital expenditure of the entire industry. It said JPMorgan Chase was the world’s biggest “fossil banker”, providing $195bn over three years, followed by Wells Fargo, Citi and Bank of America. In Europe, Barclays has been the biggest backer of oil, gas and coal companies, according to the responsible investment charity Share Action, providing more than $85bn of finance since the Paris Agreement was signed in 2015. HSBC and Standard Chartered have also been named by Dutch charity BankTrack as among the biggest lenders to coal projects. Banks said they have been responding to the climate challenge, although tackling it through changes to global regulation may prove difficult.

Huw van Steenis, chair of UBS’s sustainable finance committee, noted the point he made in his “Future of Finance” review for the Bank of England: “Many banks highlight that they are primarily regulated through risk-weighted assets, which are based on historical information and expert analysis. They do not always take account of longer-horizon forward-looking information such as climate change. And while adjusting the risk weights . . . might merit discussion, it would not be easy to operationalise, given the globally agreed approach to setting capital requirements.” 

Still some investors are pressing regulators to do more. In March this year, Christopher Hohn, founder of the $28bn hedge fund group TCI, called on regulators to increase the risk weighting on this lending. “Regulators cannot allow banks to hide coal loans and the totally unrealistic risk weightings being used,” he said. “Using a 250 per cent risk weighting would make new and existing coal loans uneconomic.” Finance Watch is calling on the European Commission to impose its higher risk weightings now, and hopes the Basel Committee and the Financial Stability Board will promote a similar approach globally. “Given the short time available, there is a need for decisive and immediate regulatory action, using prudential tools already available,” Mr Philipponnat said.