Climate change could ignite a financial crisis, IMF official says

Climate change poses serious risks to the stability of the financial system, a senior International Monetary Fund official told CNN Business.

Tobias Adrian, director of the IMF’s monetary and capital markets department, said the climate crisis could “absolutely” ignite a financial crisis.

“The climate crisis is slow in the making, but it’s potentially disastrous,” Adrian said in an interview from the sidelines of the Green Swan Conference, a virtual event focused on how the financial industry can take action against climate risks.

Adrian, a former official at the New York Federal Reserve Bank, pointed to how the economies of the Bahamas, Philippines and other nations have been crushed by hurricanes and typhoons in recent years.

“There are many countries where you see the climate catastrophe is catastrophic for the financial system,” he said. “Even if you don’t believe it’s the central scenario, there is still quite a bit of downside risk. And risk management is all about making sure that even in the worst cases, you are able to survive.”

‘Shocks to the financial system’

The comments echo a warning made last September in a federal report that acknowledged “climate change poses a major risk to the stability of the US financial system and to its ability to sustain the American economy.”

The report, published by the climate subcommittee of the US Commodity Futures Trading Commission, implored regulators to “more urgently and decisively” work to address looming economic damage from climate change.

In March, researchers at the Federal Reserve wrote in a report that climate-related economic or financial risks may not necessarily impact financial stability, though they acknowledged that is a possibility under certain scenarios.

Storms, floods, wildfires or other acute hazards can quickly change or reveal new information about the economic outlook or the value of financial assets, the Fed report said.

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“Climate risks can manifest as shocks to the financial system,” the researchers wrote.

The Fed researchers added that economic and financial risks can amplify one another, for example if weather-related property destruction sparked bank losses that led to less lending and reduced investment.

“With the potential for sudden, large shifts in perceptions of risk, chronic hazards could produce abrupt repricing events, if investor expectations or sentiment about the physical risks change abruptly,” the report said, adding that more research is needed to better understand these risks.

Climate stress tests

US financial regulators, after taking a largely hands-off approach during the Trump administration, have only just begun to examine these risk factors. In December, the Fed formally joined the Network of Central Banks and Supervisors for Greening the Financial System, one of the co-sponsors of the Green Swan Conference.

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Treasury Secretary Janet Yellen said last month that she and President Biden are “committed to using the full power of the US federal government to address climate change.”

Adrian outlined four key areas where climate should be incorporated into financial regulation, including by introducing climate stress testing of physical risks and how exposed economies are to the energy transition.

“The climate crisis is an existential crisis,” the IMF official said. “It will require a certain degree of shifts in how we look at exposures. That is the point of climate stress tests: to make investors aware. In capital markets, the shift is already happening.”

While the IMF is already conducting climate stress tests on some countries, such an evaluation would require regulatory or even legislative changes in the United States.

Is climate in the Fed’s mandate?

Adrian also called for revamped standards for data and disclosure around climate risks to boost transparency.

“Climate data is very noisy at the moment. It’s very hard to classify to what degree a given company is green or brown,” he said.

Gary Gensler, chairman of the Securities and Exchange Commission, recently told Congress he plans to introduce new rules around corporate climate disclosures later this year.

Meanwhile, Adrian said regulators must do more work on how to regulate financial institutions in a way that makes the system more climate friendly. “That is still in its infancy,” he said.

Lastly, Adrian said central banks need to evaluate how to incorporate climate into monetary policy and asset purchases — a step that the IMF official acknowledged is “quite controversial.”

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Indeed, a dozen Republican senators wrote a letter to Fed Chairman Jerome Powell in March questioning the central bank’s jurisdiction and expertise in environmental matters.

“This effort is not grounded in science or economics,” they wrote, “but is instead a self-fulfilling prophesy: claim there are financial risks with energy exploration and other disfavored investments then use the levers of government — via the unelected bureaucracy — to ban or limit those activities.”

Fed Chairman Jerome Powell pushed back by pointing out the US central bank supervises banks.

“The reason we’re focused on climate change,” Powell said during a speech in April, “is that our job is to make sure that financial institutions, banks, particularly the largest ones, understand and are able to manage the significant risks that they take.”