‘Uninsurable and unhedgeable’: Central Banks warn of financial crisis from climate change

A future climate disaster, or “green swan” event, could bring down the global financial system, according to a new report from the Bank for International Settlements (BIS), an international financial organization that serves as a bank for central banks around the world.

Like black swan events, “green swan” events will be very difficult to predict and will hit with little warning. The potential for a cascading series of crises stemming from climate change threatens global financial stability, and the world’s central banks are not equipped to respond to them, or even predict what exactly might unfold, the 100-page BIS report said.  

Risk in the time of climate change

The financial risk from climate change is typically put into two categories: physical risk and transition risk. The former refers to natural disasters or some other climate-related calamity that imposes steep costs on society from physical damage, such as a drought or a hurricane.

Transition risk refers to the repricing of assets as the global economy shifts towards cleaner energy, such as an oil company losing much of its value following the passage of a painful carbon tax.

#ClimateChange is a “green swan” risk that may cause extreme events, large financial losses and possibly the next systemic crisis. How can central banks & supervisors preserve #FinancialStability? A joint BIS-@BanquedeFrance book looks for answers @NGFS_ https://t.co/S5KI2omUqY pic.twitter.com/4rHiAux0mB

— Bank for International Settlements (@BIS_org) January 22, 2020

Both types of risk “are characterized by deep uncertainty and nonlinearity,” BIS said. Worse, they will interact with each other, resulting in feedback loops that could deepen financial stress. The destruction of coastal real estate could trigger bank failures or the collapse of insurance markets as losses pile up, for example. The ripple effects are difficult to predict, and the 2008-2009 financial crisis is a reminder that the financial system can seize up in an instant.

However, green swan events are different from a typical “black swan” event in that while the details or timing of the disaster are unpredictable, there is nevertheless a high degree of certainty that climate catastrophes will indeed happen. And they are “even more serious than most systemic financial crises: they could pose an existential threat to humanity,” the BIS report warned.

Bailing out the atmosphere?

Central banks have dangerously few tools at their disposal to respond to climate-related financial crises. Ahead of time, central banks can do stress tests, work with financial markets on disclosure, study regulation, and recommend certain policies. They can also exclude debt of carbon-intensive industries when they purchase bonds, for instance, or require lenders to hold more capital reserves.

But “climate-related risks will remain largely uninsurable or unhedgeable as long as system-wide action is not undertaken,” the BIS said.

Even as they remain ill-equipped to head off disaster, central banks “may inevitably be led into uncharted waters” as the climate crisis unfolds, forcing them “to intervene as ‘climate rescuers of last resort’ and buy large sets of devalued assets, to save the financial system once more,” the report warned.

However, central banks cannot buy up entire swathes of coastline that go under water, or rescue collapsed industries left behind in the transition. Ultimately, central banks cannot bail out the carbon-loaded atmosphere as if it were a tranche of toxic mortgage assets that simply need to be removed from the balance sheet. “The biophysical foundations of such a crisis and its potentially irreversible impacts would quickly show the limits of this ‘wait and see’ strategy,” the report warned.  

Warnings abound

This is not the first time that someone has warned about climate change bringing down the financial system. The governor of the Bank of England, Mark Carney, has warned for years about the financial risks from a changing climate and did so again recently. Various organizations have warned of “stranded assets” for years.

Some of the largest private financial institutions in the world have begun to reduce their exposure to fossil fuels. BlackRock, the largest asset manager in the world, made headlines in January when it announced that it would divest from coal companies. In a letter outlining the decision, BlackRock said that “climate risk is investment risk.”

But the latest report from the BIS is notable because of who is issuing the warning. The BIS is an organization made up of 60 central banks from around the world, including the U.S. Federal Reserve and the European Central Bank. It’s often likened to the central bank of central banks.

In other words, this is not an environmental group or even a collection of socially responsible investors urging a greening of finance. Rather, the world’s most powerful financial institutions are sounding the alarm that “a new global financial crisis triggered by climate change would render central banks and financial supervisors powerless,” as the report warned.

Released shortly after the conclusion of the warmest decade in recorded human history, the BIS report urged global governments to move aggressively to slash climate emissions.

Oil industry heads to Davos

Against this grim backdrop, oil titans traveled to Davos, Switzerland, in mid-January for the World Economic Forum. Industry executives met with bankers and even OPEC officials amid growing pressure for climate action. By many accounts, concerns about climate change dominated the proceedings in Davos and oil executives scrambled to mount a plan of action.

Despite the pressure, the oil executives fell back on a familiar playbook. Their response? “Lure investors with higher returns and raise the PR game,” as Reuters put it.

Key economic decision makers see climate risks as top long-term concerns. The risks include extreme weather events, failure to properly plan for climate change, man-made environmental disasters such as oil spills, and major biodiversity loss. #ActOnClimate https://t.co/1FuDKTSteG

— NRDC Action Fund (@NRDC_AF) January 26, 2020

“There is no doubt — and there is a consensus coming here in various meetings in Davos — that our industry is literally under siege and the future of oil is at stake,” said Mohammed Barkindo, secretary-general of OPEC, according to Reuters. “The industry needs to come together and respond positively with facts and figures. We are not shying away from the fact that we have not been able to communicate well.”

Last year, Barkindo said that climate activists and their “unscientific” claims are “perhaps the greatest threat to our industry going forward.”

In Davos, other oil executives agreed. “How do you get the hearts and minds of investors back? That is a real challenge for our industry,” said John Hess, CEO of Hess Corp., an independent oil company.

In the face of worsening climate crisis, Hess thinks that the “real challenge” for the oil industry is winning back the hearts and minds of investors. Meanwhile, Hess is in the process of developing a string of oil discoveries off the coast of Guyana in partnership with ExxonMobil, which won’t reach full production until the mid-2020s and will operate indefinitely thereafter. The industry shows no signs of slowing down.  

DeSmog has spent years exposing the bad-faith PR behind the oil industry. The public is increasingly aware of the industry’s obfuscation. But even at this late stage, with the climate crisis worsening and even with the world’s central banks sounding the alarm, the oil industry’s response in Davos amounted to a decision to engage in yet another round of advertising.