The fallout from the effects of climate change could echo through — and be amplified by — the global financial system, ultimately posing a threat to financial stability, warns a new report from the Financial Stability Board (FSB).
The policy group published a report that examines the possible implications of climate-related risks — both physical risks and transition risks — for the financial system.
Physical risks, the FSB said, “could lead to a sharp fall in asset prices and increase in uncertainty.” At the same time, a disorderly transition to a more sustainable, low-carbon economy “could also have a destabilizing effect on the financial system,” the FSB warned.
Both sets of risks may also alter how the global financial system deals with shocks.
“They may give rise to abrupt increases in risk premia across a wide range of assets,” the FSB said, adding that physical and transition risks could also affect asset correlations, amplify an array of market risks (such as credit, liquidity and counterparty risks) and upend financial risk management.
“Such changes may weaken the effectiveness of some current approaches to risk diversification and management. This may in turn affect financial system resilience and lead to a self-reinforcing reduction in bank lending and insurance provision,” the FSB said.
The FSB also suggested that the “breadth and magnitude of climate-related risks” might make the fallout from climate change deeper and more damaging than conventional economic risks.
“Moreover, the interaction of climate-related risks with other macroeconomic vulnerabilities could increase risks to financial stability,” the FSB warned.
While many financial firms are taking action to manage their exposure to climate-related risks, the FSB said that these efforts may be hampered by a lack of data on clients’ risk exposures and uncertainty about the magnitude of these effects.
The FSB said that it will continue working to improve the quality and availability of climate data. It is aiming to complete this work by October 2021.