The risks of climate change to the economy
The Central Bank’s Financial Stability Review (FSR) is, as the title suggests, one of its big tome publications published twice a year, which goes into great detail on various threats to the financial system.
Being Ireland, this normally boils down to a public discussion over rules on mortgage lending and what’s happening in the property market.
But buried in the review published last week, was a significant and noteworthy two-page box. It was written by Yvonne McCarthy, an economist with the Bank’s Climate Change Unit, which was set up earlier this year.
It’s the first time climate change has received particular attention in the bank’s biannual review of systemic risks to the financial system.
There are voluminous reports on every aspect of climate change published both in Ireland and internationally, so why is two pages in the middle of reams of data on credit ratings and capital ratios important?
The future existence of the planet and our species may seem an issue that’s far more important than the stability of the financial system.
But it’s a consequence of the way we organise ourselves on this planet that things tend not to happen until they are engineered to do so through the loose collection of interconnecting arrangements we broadly call the economy.
So the fact that the Central Bank now considers climate change a factor in and risk to our financial stability is a significant departure.
The Central Bank, as part of the European Central Bank, is responding to climate change by doing what central banks do. It’s assessing and measuring the scale of the challenge that’s upon us.
In March, ECB Vice President Luis de Guindos gave some detail about a mass “climate stress test” that’s currently under way to gauge how four million companies and 2,000 banks will cope under different climate scenarios.
Not surprisingly, mining, transport and agriculture are the industries considered most exposed. The latter is a particularly important and controversial one for Ireland.
The European Systemic Risk Board, also part of the ECB system, has calculated that the costs of natural disasters arising from climate change from 1980-2018 was a colossal €537bn, with only 35% of that insured.
It goes to on to estimate that the transition to a low carbon economy will cost the energy sector between US$1trillion and US$4trillion and could cost the broader global economy US$20trillion.
The same report estimates that the physical damage from climate change could cost between 10% and 20% of global GDP by the end of this century.
The broad principles in the Central Bank’s take on climate change is that early action is necessary to avoid an even greater cost in the future. It defines the risks as ‘physical’ and ‘transitional’.
Physical risks are the direct costs of events such as floods and hurricanes. Transitional risks are what might happen when industries get caught up in the change to a low carbon economy.
Direct cost of tackling climate change
It cites the simple example of buildings with low-energy efficiency, which could fall in value by abrupt changes in what people demand of their buildings or through public policies.
It describes climate change as a “structural shock” and admits that traditional ways of looking at what things are worth in the economy ‘are unlikely to be sufficient’.
That means climate change is going to change the way companies and banks are valued. And it could possibly mean some will be worth less as the world changes.
And then there’s the direct cost of tackling climate change.
The Parliamentary Budget Office attempted to quantify what climate change measures might cost the Exchequer shortly after the first Climate Action Plan was published in 2019.
It came up with a figure of between €30-€40bn under the National Development Plan.
But that didn’t, as far as I know, factor in the potential loss in tax revenue as the use of diesel and petrol cars decline and heating systems switch from fossil fuels.
Climate change is going to cost an awful lot of money. And as my colleague George Lee reported this week in relation to the EU’s CAP programme: when it is spent it doesn’t always achieve the desired result.
Greenhouse gas emission targets are, of course, an important part of defining progress in tackling climate change. But calculating the cost of climate change and placing that in our financial system may bring into sharper relief what lies ahead.
Financial targets, as we learned during our bailout years, have a habit of concentrating the mind.