'Green swans' will trigger the next crisis: BIS
"Transition risks are associated with the uncertain financial impacts that could result from a rapid low-carbon transition, including policy changes, reputational impacts, technological breakthroughs or limitations, and shifts in market preferences and social norms," BIS said.
"In particular, a rapid and ambitious transition to lower emissions pathways means that a large fraction of proven reserves of fossil fuel cannot be extracted becoming 'stranded assets', with potentially systemic consequences for the financial system."
"For instance, an archetypal fire sale might result if these stranded assets suddenly lose value, 'potentially triggering a financial crisis'," it said.
BIS cites Bank of England governor Mark Carney who has highlighted that too rapid a movement towards a low-carbon economy could "materially damage financial stability", "destabilise markets, spark a pro-cyclical crystallisation of losses and lead to a persistent tightening of financial conditions".
The report said the value added of many other economic sectors dependent on fossil fuel companies would "probably be impacted indirectly by transition risks" however it also notes that delaying a transition could have even worse financial stability risks in the long term.
"In contrast, delayed and weak action to mitigate climate change would lead to higher and potentially catastrophic physical risks, without necessarily entirely eliminating transition risks."
Climate change, BIS said, could have long-standing impacts on agricultural yields, lead to frequent resource shortages or to a loss in hours worked due to heat waves reducing output and creating demand shocks, such as reducing household wealth and consumption.
With such distortions to inflation and economic growth a new challenge for central bank monetary policy would open up.
"If climate-related risks end up affecting productivity and growth, this may have implications for the long-run level of the real interest rate, a key consideration in monetary policy."
Central banks buy lower return bonds?
BIS suggests a range of actions central banks could invest in to help mitigate the threats such as "examining the adequate room to invest surplus foreign exchange reserves into green bonds".
In September last year BIS launched its green bond BIS Investment Pool Fund, a new vehicle that facilitates central banks’ investments in green bonds.
"By accepting potentially lower financial returns in the short run to ameliorate longer-term social and environmental results, time can be valued in a manner that better corresponds to environmental systems’," BIS suggested.
It also said central banks could develop new methodologies to improve the assessment of climate related risks; including environmental, social and governance (ESG) criteria in their pension funds.
They could also help to develop and assess the proper taxonomy to define the carbon footprint of assets more precisely and work closely with the financial sector on the disclosure of carbon-intensive exposures which could help mitigate potential financial stability risks.
"Transition risks are associated with the uncertain financial impacts that could result from a rapid low-carbon transition, including policy changes, reputational impacts, technological breakthroughs or limitations, and shifts in market preferences and social norms," BIS said.
"In particular, a rapid and ambitious transition to lower emissions pathways means that a large fraction of proven reserves of fossil fuel cannot be extracted becoming 'stranded assets', with potentially systemic consequences for the financial system."
"For instance, an archetypal fire sale might result if these stranded assets suddenly lose value, 'potentially triggering a financial crisis'," it said.
BIS cites Bank of England governor Mark Carney who has highlighted that too rapid a movement towards a low-carbon economy could "materially damage financial stability", "destabilise markets, spark a pro-cyclical crystallisation of losses and lead to a persistent tightening of financial conditions".
The report said the value added of many other economic sectors dependent on fossil fuel companies would "probably be impacted indirectly by transition risks" however it also notes that delaying a transition could have even worse financial stability risks in the long term.
"In contrast, delayed and weak action to mitigate climate change would lead to higher and potentially catastrophic physical risks, without necessarily entirely eliminating transition risks."
Climate change, BIS said, could have long-standing impacts on agricultural yields, lead to frequent resource shortages or to a loss in hours worked due to heat waves reducing output and creating demand shocks, such as reducing household wealth and consumption.
With such distortions to inflation and economic growth a new challenge for central bank monetary policy would open up.
"If climate-related risks end up affecting productivity and growth, this may have implications for the long-run level of the real interest rate, a key consideration in monetary policy."
Central banks buy lower return bonds?
BIS suggests a range of actions central banks could invest in to help mitigate the threats such as "examining the adequate room to invest surplus foreign exchange reserves into green bonds".
In September last year BIS launched its green bond BIS Investment Pool Fund, a new vehicle that facilitates central banks’ investments in green bonds.
"By accepting potentially lower financial returns in the short run to ameliorate longer-term social and environmental results, time can be valued in a manner that better corresponds to environmental systems’," BIS suggested.
It also said central banks could develop new methodologies to improve the assessment of climate related risks; including environmental, social and governance (ESG) criteria in their pension funds.
They could also help to develop and assess the proper taxonomy to define the carbon footprint of assets more precisely and work closely with the financial sector on the disclosure of carbon-intensive exposures which could help mitigate potential financial stability risks.
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