Climate Finance And Financial Stability: Some Areas For Further Work – Speech

Climate change has become an utmost priority. While it has several dimensions, our focus today is on those aspects of climate change that could disrupt macroeconomic and financial stability.

Recent global stress episodes remind us of the importance of crisis preparedness and resilience building. The COVID-19 crisis demonstrated how “tail events” can cause extensive disruption of economic activity. And the repercussions of the war in Ukraine have made evident the urgency to cut dependency on carbon-intensive energy and accelerate the transition to renewables.

Tackling climate change is critical to ensuring a healthy planet, but it also makes good economic sense. Studies have shown that the social gains far outweigh the costs of climate financing. There is now a sizeable and growing body of literature providing quantitative estimates on the “social cost of carbon.” This measures the incremental harm from climate change caused by additional carbon emissions. And evidence now shows that avoiding emissions and moving to renewables would result in significant social benefits and an overall net gain for society.

Potential risks to energy transition could amplify risks to the financial system. Risks to energy transition could arise if the perception of the trade- off between energy security and transition changes rapidly and net-zero transition becomes costly, complex, and disorderly. Given Russia’s large share in global commodity production beyond oil and gas, commodity prices, including those used as raw materials for renewables—such as aluminum, copper, and nickel—have risen sharply. The energy-related repercussions from the war in Ukraine may also alter the speed of phasing out fossil fuel subsidies in emerging markets and developing economies.

A delayed or disorderly climate transition could magnify the risks to the financial system Therefore, at the IMF, we have prioritized gaining a more holistic understanding of the implications of climate change for the global financial system and financial stability.

Let me lay out seven areas of climate finance and financial stability that needs more vigorous attention by central banks and financial regulators. I hope these will help in the policy dialogue over the next two days.

First, policymakers need advice on climate-related macro-financial policies. These policies have a crucial role to play because of two main factors. The first is the magnitude and global nature of the potential economic and financial stability risks. The second is the strong positive relationship between climate protection on the one hand and macroeconomic performance and financial stability on the other.

Last year, we published a climate strategy that recognized a more systematic and strategic integration of climate change into the IMF’s activities. Growing demand from our member countries to assess macroeconomic and financial implications of climate change demonstrated the need to step up our climate-related work. Our bilateral and multilateral surveillance is giving more significant focus to climate-related issues, and we are increasing climate-related capacity development.

Second is the urgent need for structural reforms to minimize the impact of climate change on the financial system. One of the reasons this has been stalled in the developing markets is the lack of proper financing to affect structural changes. The IMF is stepping up to help provide affordable financing to support countries in tackling structural challenges, including climate change. The new Resilience and Sustainability Trust, approved recently by the IMF Executive Board, will channel SDRs and address these macro-critical longer-term challenges that pose significant macroeconomic risks to member countries. But more is needed in this area.

Third, central banks and financial regulators must systematically integrate climate risk assessments into their financial stability frameworks. When climate risks are deemed material and systemic importance exists, special attention will be needed to ensure the evaluation of how climate risks amplify and transmit risks to the financial sector.

The fourth relates to the regulation and supervision of climate-related financial risks. Preserving financial stability is the core mandate of financial supervisory authorities, who should therefore ensure that climate-related risks are adequately captured in their supervisory processes. Where these risks are assessed as being material and likely to threaten financial stability, supervisors should then be able to intervene early. We are all learning by doing but building capacity in this area is important.

The fifth relates to central banks’ mandates and balance sheets. Thanks to the NGFS, a lot of good technical work is coming about, but, again, more analytical work is required to assess the impact of climate change on central bank operations, governance framework, policy-setting framework, and financial stability. We need to evaluate—within the mandate of central banks—how environmental sustainability objectives should influence central bank operations and the use of monetary policy tools, and to integrate sustainability considerations into central banks’ balance sheets.

The sixth issue relates to the strengthening of climate information architecture. Assessing climate risks, allowing accurate market pricing, and enabling informed investment decisions require a robust information architecture around climate risks. The information architecture consists of three components: first, reliable and high-quality data; second, a harmonized and consistent set of climate disclosure standards; and third, principles to align investments to sustainability goals. Implementing a global climate information architecture may also serve as the foundation to develop sustainable finance markets in emerging and developing economies. In this regard, current standard-setting work should fully take into consideration the difficulties in data collection in emerging markets,while ensuring that company-level disclosures are mainstreamed across these economies. We have Ravi Menon, Sarah Breeden, and Fabio Natalucci, who are taking forward — via the NGF — the work on improving climate architecture.

The seventh and final area that needs action is ways to mobilize both public and private finance, while keeping the balance with other economic needs of the country. We need to understand the potential avenues to scale up private financing to mitigate climate risks, which is required to develop sustainable finance markets. Access to finance continues to be a barrier in many economies. In some economies, climate finance flows need to increase by 4 to 8 times until 2030, according to the latest estimates from the Intergovernmental Panel on Climate Change.

Momentum is continuing to build on climate financing and other initiatives, but we need to act now to ensure the necessary frameworks are in place in the years ahead. As the Managing Director mentioned in her welcome remarks, carbon pricing should be at the center of efforts to reduce emissions. Everyone must play a role in scaling up work and effort on climate-related financial stability and climate finance.

Through this regional policy dialogue, I sincerely hope that we will benefit from a frank exchange of challenges countries face and what must be assigned as our collective immediate vs. medium-term priorities.

Thank you and all the very best.

Opening Remarks by Tobias Adrian, delivered at the IMF Policy Dialogue on Climate-Related Financial Risks and Green Finance in Asia and the Pacific