Could Climate Change Trigger A Financial Crisis?
The clearer governments are about emissions reduction, the less likely financial turbulence becomes
The financial system could also be exposed to any wider economic damage caused by climate change, say if it triggered swings in asset prices. This third channel is harder to quantify. Academic estimates of the effect of 3°C of warming (relative to pre-industrial temperatures) veer from financial losses of around 2% to 25% of world GDP, according to the Network for Greening the Financial System, a group of supervisors. Even the gloomiest estimate might prove too rosy if climate change triggers conflicts or mass migrations.
Perhaps the worst-case scenario for the financial system is where transition risks crystallise very suddenly and cause wider economic damage. In 2015 Mr Carney described a possible “Minsky moment”, named after Hyman Minsky, an economist, in which investors’ expectations about future climate policies adjust sharply, causing fire sales of assets and a widespread repricing of risk. That could spill over into higher borrowing costs.
The value of financial assets exposed to transition risk is potentially very large. According to Carbon Tracker, a climate think-tank, around $18trn of global equities, $8trn of bonds and perhaps $30trn of unlisted debt are linked to high-emitting sectors of the economy. That compares with the $1trn market for collateralised debt obligations (CDOs) in 2007, which were at the heart of the global financial crisis. The impact of losses, however, would depend on who owns the assets. Regulators might be especially concerned about the exposures of large, “systemically important” banks and insurers, for instance.