Lost in transition

Let’s be honest – transition risk is a fickle beast.  

On paper it makes sense that abrupt shifts in climate policy, a sudden pricing of carbon pollution, and/or the rollout of some new über-green technology could upset the economy and send financial institutions for a spin.

However, appreciating a risk in theory and figuring out what its impacts could be in practice are two different things – as the Bank of Canada (BoC) recently came to learn.  

In a December paper ‘Understanding the Systemic Implications of Climate Transition Risk’, bank researchers presented an analytical framework to identify the transmission channels through which transition risks “could spread across entities and impact the broader financial system.”

It’s a worthy endeavor.  Transition risks are already bubbling up in odd corners of the financial system.  They manifested recently in the Netherlands, where the lender Rabobank downgraded the creditworthiness of a whole portfolio of dairy farm loans off the back of the Dutch government’s plans to reduce the country’s nitrogen emissions, the bulk of which are the product of ruminant cattle.  One imagines the twists and turns in the electric vehicles saga are currently sending auto loan portfolios for a loop, too.

However, it turns out trying to translate transition risks into potential financial impacts, and particularly systemic impacts, is a tough ask.  Right from the start of the paper, the BoC researchers make clear the limitations of their analysis.  Data issues, like working with “non-harmonized datasets” are one problem.  The exclusion of the liability side of balance sheets is another.