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Is the climate too big to fail? Central bankers say yes

Regulators see global warming as financial and economic risk

SINGAPORE -- If you Google "what do central banks do?" the answers will include "manage currencies" and "set interest rates."

"Fight climate change" doesn't come up -- but maybe it should.

A growing number of central banks around the world are starting to view climate change as a threat to financial stability, and therefore an issue that falls under their purview.

This idea began to take shape in December 2017, when eight central banks and financial supervisory agencies established the Network for Greening the Financial System. The purpose of NGFS was to start a discussion around the magnitude of the risk that global warming poses to the financial system.

In a year and a half it has grown to 36 members, including representation from Asian countries such as China, Singapore, Japan, Malaysia and Thailand. (Notably, the U.S. is not a member.)

This rapid expansion is a clear indication of how seriously financial regulators around the world are taking the issue.

"Climate-related risks are a source of financial risk, and it therefore falls squarely within the mandates of central banks and supervisors to ensure the financial system is resilient to these risks," says Frank Elderson, chair of the NGFS and the representative of the Dutch central bank.

The group published its first full-scale proposal in April this year. It examines the ways extreme weather related to climate change damages assets and causes a significant decline in their value -- and thus poses risks to the stability of the financial system.

Addressing climate risks from a financial perspective was first proposed by U.K. central bank governor Mark Carney in 2015, the year the Paris Agreement was drafted. The NGFS report, which was influenced by Carney's analysis, contains a number of suggestions ranging from very big-picture ideas -- "scenario analysis ... to help central banks and supervisors assess how climate change will impact the macroeconomy" -- to the more practical, such as the need to train employees to identify and analyze climate risks.

The group is working to develop a taxonomy for economic activities that foster the transition to a green, low-carbon economy, and others that are more exposed to climate- and environment-related risks.

The European Union is also working on a classification system of its own, which is likely to be closely watched by regulators around the world.

"Japanese financial institutions should pay more attention as to how the international financial supervisors [like NGFS] and the EU will cooperate with each other," said Chie Mitsui, an ESG expert at Nomura Research Institute. "If the EU taxonomy is applied to financial regulation, it could urge banks to shift financing from environmentally-unfriendly projects to friendly ones."

For instance, if the EU defines solar power facilities as less risky than coal-fired power plants, and bank regulators employ these definitions, then financial institutions would want to reduce their exposure to coal and increase their exposure to solar.

Naoko Nemoto, an economist at the Asian Development Bank Institute, notes that "ESG [and especially environmental] rule-making has been driven by Europe."

One environmental expert who saw the draft paper of EU taxonomies noted, on condition of anonymity, that they could pose a threat to the interests of Japanese and Asian banks with large exposures to coal-fired power plants.

"Japan should be actively engaged in the international rule-making on ESG, especially 'E,'" says Mana Nakazora, an ESG analyst at BNP Paribas.

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