Blip, crisis or collapse: why financial regulators need to prepare for more than a climate crisis
Posted on 16.06.22
It’s now or never. That was the headline from the latest summary report from the IPCC describing the need for more urgent action. The “certainty” and “need for urgency” was already abundantly clear. What’s now emerging in the IPCC’s scientific analysis is the irreversibility of climate change – the devastating effects will continue for “centuries or millennia”, long after emissions stop.
When we think about addressing the risks of global climate change, central banking rules are hardly likely to be top of most people’s minds. Banking regulation is often shaped by the response to the last crisis, and central bankers have been reticent to adapt their processes sufficiently to anticipate situations they have yet to experience.
Take the reflection of Ben Bernanke, chair of the Federal Reserve during the global financial crisis. Speaking in 2010, he claimed that “calls for a radical reworking of the field go too far… Economic models are useful only in the context for which they are designed. Most of the time, including during recessions, serious financial instability is not an issue. The standard models were designed for these non-crisis periods, and they have proven quite useful in that context”.
In other words, the tools we use to keep us safe are often built for the times which we have experienced in the past and don’t include the risks we see ahead of us.
Is financial regulation fit for purpose?
Many commentators have asked: could climate change create a financial crisis like the last one? Thinktanks and financial experts certainly think so. Both Graham Steele at the US Treasury and Brussels-based NGO Finance Watch have warned of a climate Lehman moment. The World Resources Institute has observed that “the climate crisis could absolutely induce a financial crisis”.
So should our financial regulations anticipate and deal with a future financial crisis caused by climate based on previous crises? Well, yes and no.
There is inevitable loss and damage as a consequence of climate change up to 1.5ºC. Central banks will start to open their crisis management toolkit with scenario analyses and stress tests. But the science explains that when we go beyond climate thresholds, overshooting safe limits and triggering feedback loops, then we’re not facing a crisis, we’re facing a collapse.
That’s not just a more exaggerated form of language. It’s a different category with inherently different implications for regulators.