The knowns and unknowns of climate financial risk

To my mind, there are three reasons why financial regulators should be concerned about climate-related financial risk.

The first, and most obvious, is as a cudgel to force banks to take the problem of global warming seriously – and to do something about it.  But this is both unnecessary and unlikely to be successful.  It is unnecessary because, really, does the destruction of the planet and the broader risk to humanity provide insufficient motivation for banks to act?  It is unlikely to be successful because the private interests of banks are closely aligned with the forces creating a hotter planet.  Banks like economic growth whether it is sustainable or not.  Claims that banks’ interests are threatened by climate change are incongruent with their experiences, and therefore ring hollow.

The second reason is to determine an appropriate capital surcharge to cover the elevated financial risk that climate change is theorized to present to the financial system.  But even if this higher risk exists, shoring up the banks is a second-order concern compared to the more pressing need to vigorously address the climate crisis.  Capital is required for this effort and should be freely available, not locked up to cushion the banking system from some nebulous long-term threat.  If this situation changes and climate risk starts to materialize, extra capital can, of course, be raised.  Banks are well cushioned at present and will easily be able to absorb any initial climate-related losses without calling on the public purse.  Put simply, extra climate capital can wait – it’s not helpful right now.

The third reason – the one I want to focus on today – is to better equip the industry to handle climate risk in whatever form it takes.  I think this is an important game, and one we should all be playing.  I’m normally not explicit about it, but it motivates much of my writing.  An example is the piece we posted on Monday that tried to explain why property developers aren’t always ruined by the destruction of the buildings they own.

Truly getting better at managing climate risk depends on an honest appraisal of what we do and don’t know about the topic.   It’s this honesty that is generally lacking at present in the industry.  People claim to know things they couldn’t without the aid of a time machine, and gloss over obvious truths that they should be trying hard to explain.  This lack of honesty is holding us back from getting to grips with the financial implications of the unfolding crisis.