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Speech Frank Elderson - “From climate risk to financial risk – getting used to the new normal”


Gepubliceerd: 17 juni 2020

Frank Elderson

At the ECB Webinar on environmental and climate risks, Frank Elderson shared his thoughts on how the issues arising from environmental and climate-related risks should be taken into account by the banking industry and banking supervision

Datum: 17 juni 2020
Locatie: ECB Webinar on environmental and climate risks – Industry Dialogue.
Spreker: Frank Elderson

Thank you for inviting me to speak to you today, not so much in my role as member of the Supervisory Board, but as Chair of the Network for the Greening of the Financial System.

Like me, I am sure that by now you are all used to online events like this. It’s just one of the many ways our world has changed in the last few months. But it’s not just how we work that has changed; it’s how we travel, how we behave in public, how we buy our food, how we socialize, even how we wash our hands.
What at first seemed strange to us, has now become the new normal. Of course, all these changes in our lives are necessary to reduce the risk of spreading COVID-19.

But we are here this morning to address the risks from that other global crisis. It may be unfolding much more slowly, but its effects are no less severe. And unlike the pandemic, these risks are not temporary – but will be with us for generations to come.

Climate change and environmental breakdown do not get much airtime in the media right now.

So you may have missed reports that last month was the hottest May on global record. And most Dutch people have no idea that the Netherlands suffered its worst ever forest fire just a couple of months ago.

Climate change also leads to a financial risks, which are already present today. Just a few days ago one of the largest oil companies announced that it will write off 17.5 billion dollars from the value of its assets as it expects a quicker shift away from fossil fuels. The devastating wildfires in Australia earlier this year also caused billions of financial damage to the economy.

So the risks of climate change and environmental breakdown are here to stay. Which is why all of us have to work together to appreciate the seriousness of these risks, and to start preparing for the changes they will bring.

As I said, what may seem strange to us today, can quickly become the new normal of tomorrow. So it is important not to get caught out, either by the speed of the transition towards sustainable energy, or by the rate at which our climate is changing. That means it is in all our interests to act so we can stay ahead of the game and ensure an orderly transition, and build a financial sector that takes full account of climate and environmental risks, rather than just paying them lip service.

I am happy to say that the Network for Greening the Financial System has come a long way to help achieve this. By fostering cooperation between central banks and the industry, we have been able to produce some very valuable work.
And we’ve come such a long way since the NGFS was launched just two and a half years ago. We started out with only eight members. Now we have 66 members and 12 observers. This rapid growth in our membership reflects a growing realization, not just in Europe but around the world, that climate and environmental risks are also a source of financial risks.

Just a few weeks ago, the NGFS published a guide for supervisors with five recommendations on how they can integrate climate-related and environmental risks into their work.

These recommendations cover:
- identifying the risks
- building capacity
- assessing the risks of financial institutions,
- setting supervisory expectations, and
- mitigating the risk when needed.

This NGFS guide showcases examples from supervisors from all over the world: the Reserve Bank of New Zealand’s climate change strategy, the internal network set up by the Bank Negara Malaysia, what the Banco Central do Brasil expects from financial firms regarding risk management.

Supervisors worldwide are stepping up, and I am pleased to see: so is the ECB. The ECB guide on climate-related and environmental risks fits seamlessly into the fourth recommendation of the NGFS: setting supervisory expectations.
I would like to congratulate the ECB on their valuable work. With this new Guide, the ECB now expects banks to not only identify climate and environmental risks, but to actively classify, manage and monitor these risks.

That means integrating them into their governance and risk management frameworks. Incorporating them into their business strategies. That means understanding their impact in the short, medium and long-term. That also means developing stress-test scenarios that reflect these risks, as Andrea referred to earlier.

And –yes – that also means raising the bar for financial institutions to manage these risks.
Next week the NGFS will release a first set of reference scenarios, in combination with the first Guide to climate scenario analysis for central banks and supervisors. The NGFS scenarios will provide a common starting point for analyzing climate risks. The accompanying guide can help supervisors, for example, understand what would happen in a three degree scenario, when rising sea levels, droughts, and other adverse conditions become the new normal. Or to see what would happen to banks with carbon-heavy exposures when these assets become stranded because of stricter regulations.

To be clear – the risks go beyond just the physical and transitional risks relating to climate. This ECB guide also addresses environmental risks.
That means banks should also for example consider the impact of pollution, water shortages and the loss of biodiversity. I’m glad to see this last subject mentioned in the ECB guide. Because tomorrow, De Nederlandsche Bank will publish a report on how the decline in biodiversity and ecosystem services translates into risks for financial sector.

One example of an ecosystem service is animal pollination. Now the link between declining bee populations and bank loans may not be obvious. But banks have to consider that many of the businesses they lend to are dependent on animal pollinators. On a global scale, the balance sheet exposures to these businesses run into billions of euros.

And then there are reputational risks to consider. Banks need to be careful about the clients they engage with. If they lend to companies that have bad environmental records - say they have been responsible for deforestation or pollution - then this also harms the bank’s reputation. And as a result it will be harder for the bank to attract new clients.

Last month the NGFS published a report on the risk differentials banks apply to classify green, non-green and brown financial assets. We saw that practices around the world are very fragmented. They are mainly based on voluntary principles and standards.All these different approaches and combinations of solutions ultimately only lead to confusion and open the door to greenwashing. Several of the banks in our survey stressed the importance of developing a uniform global taxonomy framework.

So it is very encouraging to see that there is now political agreement at EU level for a common classification system for sustainable activities. The new EU Taxonomy Regulation, combined with the Regulation on sustainability disclosures is a real shot in the arm for all members of the NGFS and supervised institutions.
Progress like this is only possible through concerted, international action. Just as with Covid-19, the financial risks from climate change do not respect national borders.

So it is vital we work together. Supranational initiatives like this ECB Guide, prepared with full industry consultation, are the only way we can achieve our goal of greening the financial system.

I hope everyone here today realizes that they also have a role to play and I am pleased to see that banks have become increasingly aware of the potential significance of climate-related risks. Because the more of us there are pushing sustainable finance into the mainstream – banks and regulators – the quicker we will get over the finishing line. As chair of the NGFS I am pleased to say that all 66 members and 12 observers remain committed to playing their part.
Some of the risks I’ve mentioned today may have seemed unfamiliar back in 2017.

Back then, you wouldn’t have seen any reports with the words banking and bees in the same sentence. But just think back a few months ago to that first videoconference. In no time at all, what once seemed alien has become the new normal. And as sustainable financial practices move into the mainstream, addressing these climate and environmental risks will seem less and less alien to everyone working in the financial industry.

I started today by discussing how the COVID-19 crisis has disrupted many aspects of our lives. I’d like to end by reminding you of the opportunities we have for a green recovery from this crisis.

In the wake of the pandemic, we have a tabula rasa on which we can build a much greener financial system. The global health crisis may lead financial institutions to reconsider their principles. To reconsider the choices they make regarding sustainability and climate risk. Banks can use the current crisis as an opportunity to better understand the vulnerability of their balance sheets to climate and sustainability risks. It may prompt them to better align their investment policies and lending practices to the Paris Climate Agreement.
Banks are now providing financial support to companies and individuals. That means lenders also have the opportunity to help their customers make their business models more sustainable. And to make sure these funds go to the right places.

Unlike the 2008 financial crisis, the financial industry now has an opportunity to be part of the solution, and not part of the problem. To stop trying to sustain the unsustainable. To rebuild the economy so it is resilient to the next shock coming our way. Because unlike COVID-19, we won’t be able to self-isolate from climate change and environmental degradation.

And we won’t be able say we didn’t see it coming. Because of our combined efforts, banks and supervisors are no longer strangers to climate and environmental risks. If we keep up this momentum, keep working together, then everyone, central banks, supervisors, the entire sector, will come to view these risks as the new normal.

Thank you

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