Central banks should consider climate shocks and biodiversity when stress testing financial institutions – Financial services

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Sylvie Goulard, deputy governor of the Banque de France, the French central bank, said in a speech Oct. 24 that central banks need to take more aggressive action on nature-related risks. She postulated that “monetary valuations of ecosystem services have many limitations”, partly because of their complexity and also because “shocks” in one sector can have significant impacts on other sectors. As a result, she proposed that “the best risk mitigation strategy is to do everything in our power, early enough, to ensure we stay within planetary boundaries.” She proposed that central banks incorporate climate and biodiversity impacts into their decision-making as an aspect of their “non-monetary portfolios”; integrating nature-related concerns into central bank monetary operations, as the European Central Bank has begun to do for climate change, and implementing nature-related stress-testing exercises that address both climate and biodiversity shocks for banks and financial institutions to improve global financial stability.

Goulard concluded his speech by saying, “The task ahead of us looks like an uphill battle: university economics departments, policymakers, central bankers and supervisors are staying well behind the curve when it comes to recognizing that our socio-economic systems must undergo a radical transformation. We know that those who dare to challenge the status quo face strong setbacks or even reputational risks to their careers. They can be considered “activists” or “dreamers”. However, we have no choice but to restore nature as much as possible, as quickly as possible and finance can play a role in this task. The magnitude of the change required makes it challenging but also promising. No generation on earth for 12,000 years had such a responsibility to keep the world alive.”

Taking the temperature: Just as the CEO of BlackRock said that “climate risk is an investment risk”, Goulard seems to be saying that nature risk is a financial stability risk. Additionally, she believes that governments and businesses will struggle to understand the full range of impacts resulting from climate-related biodiversity change. This, in turn, threatens the stability of global financial systems and the businesses that operate within those systems. Financial regulators around the world, including in the United States, have weighed in on climate-related issues facing financial institutions, but less specifically regarding biodiversity. For example, the Federal Reserve Board recently announced that six of the largest U.S. banks “will participate in a pilot climate scenario analysis exercise aimed at building the capacity of supervisors and companies to measure and manage climate-related financial risks. (and that there would be no “capital or oversight implications of the pilot project”). We expect regulators to increasingly focus on nature-related climate change impacts as another aspect of risk to financial stability resulting from global warming.

(This article originally appeared in “Cadwalader Climate”, a new bi-weekly ESG market newsletter.)

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