‘Uninsurable and Unhedgeable’: Central Banks Warn of Financial Crisis from Climate Change

By Nick Cunningham, an independent journalist covering the oil and gas industry, climate change and international politics. He has been featured in Oilprice.com, The Fuse, YaleE360 and NACLA. Cross-posted from DeSmogBlog.

Like black swan events, “green swan” events will be very difficult to predict and will hit with little warning. The potential for a cascading series of crises stemming from climate change threatens global financial stability, and the world’s central banks are not equipped to respond to them, or even predict what exactly might unfold, the 100-page BIS report said.

Risk in the Time of Climate Change

The financial risk from climate change is typically put into two categories: physical risk and transition risk. The former refers to natural disasters or some other climate-related calamity that imposes steep costs on society from physical damage, such as a drought or a hurricane.

Transition risk refers to the repricing of assets as the global economy shifts towards cleaner energy, such as an oil company losing much of its value following the passage of a painful carbon tax.

Both types of risk “are characterized by deep uncertainty and nonlinearity,” BIS said. Worse, they will interact with each other, resulting in feedback loops that could deepen financial stress. The destruction of coastal real estate could trigger bank failures or the collapse of insurance markets as losses pile up, for example. The ripple effects are difficult to predict, and the 2008-2009 financial crisis is a reminder that the financial system can seize up in an instant.

However, green swan events are different from a typical “black swan” event in that while the details or timing of the disaster are unpredictable, there is nevertheless a high degree of certainty that climate catastrophes will indeed happen. And they are “even more serious than most systemic financial crises: they could pose an existential threat to humanity,” the BIS report warned.

Bailing out the Atmosphere?

Central banks have dangerously few tools at their disposal to respond to climate-related financial crises. Ahead of time, central banks can do stress tests, work with financial markets on disclosure, study regulation, and recommend certain policies. They can also exclude debt of carbon-intensive industries when they purchase bonds, for instance, or require lenders to hold more capital reserves.

But “climate-related risks will remain largely uninsurable or unhedgeable as long as system-wide action is not undertaken,” the BIS said.

Even as they remain ill-equipped to head off disaster, central banks “may inevitably be led into uncharted waters” as the climate crisis unfolds, forcing them “to intervene as ‘climate rescuers of last resort’ and buy large sets of devalued assets, to save the financial system once more,” the report warned.

However, central banks cannot buy up entire swathes of coastline that go under water, or rescue collapsed industries left behind in the transition. Ultimately, central banks cannot bail out the carbon-loaded atmosphere as if it were a tranche of toxic mortgage assets that simply need to be removed from the balance sheet. “The biophysical foundations of such a crisis and its potentially irreversible impacts would quickly show the limits of this ‘wait and see’ strategy,” the report warned.

Warnings Abound

This is not the first time that someone has warned about climate change bringing down the financial system. The governor of the Bank of England, Mark Carney, has warned for years about the financial risks from a changing climate and did so again recently. Various organizations have warned of “stranded assets” for years.

Some of the largest private financial institutions in the world have begun to reduce their exposure to fossil fuels. BlackRock, the largest asset manager in the world, made headlines in January when it announced that it would divest from coal companies. In a letter outlining the decision, BlackRock said that “climate risk is investment risk.”

But the latest report from the BIS is notable because of who is issuing the warning. The BIS is an organization made up of 60 central banks from around the world, including the U.S. Federal Reserve and the European Central Bank. It’s often likened to the central bank of central banks.

In other words, this is not an environmental group or even a collection of socially responsible investors urging a greening of finance. Rather, the world’s most powerful financial institutions are sounding the alarm that “a new global financial crisis triggered by climate change would render central banks and financial supervisors powerless,” as the report warned.

Released shortly after the conclusion of the warmest decade in recorded human history, the BIS report urged global governments to move aggressively to slash climate emissions.

Oil Industry Heads to Davos

Against this grim backdrop, oil titans traveled to Davos, Switzerland, in mid-January for the World Economic Forum. Industry executives met with bankers and even OPEC officials amid growing pressure for climate action. By many accounts, concerns about climate change dominated the proceedings in Davos and oil executives scrambled to mount a plan of action.

Despite the pressure, the oil executives fell back on a familiar playbook. Their response? “Lure investors with higher returns and raise the PR game,” as Reuters put it.

There is no doubt — and there is a consensus coming here in various meetings in Davos — that our industry is literally under siege and the future of oil is at stake,” said Mohammed Barkindo, secretary-general of OPEC, according to Reuters. “The industry needs to come together and respond positively with facts and figures. We are not shying away from the fact that we have not been able to communicate well.”

Last year, Barkindo said that climate activists and their “unscientific” claims are “perhaps the greatest threat to our industry going forward.”

In Davos, other oil executives agreed. “How do you get the hearts and minds of investors back? That is a real challenge for our industry,” said John Hess, CEO of Hess Corp., an independent oil company.

In the face of worsening climate crisis, Hess thinks that the “real challenge” for the oil industry is winning back the hearts and minds of investors. Meanwhile, Hess is in the process of developing a string of oil discoveries off the coast of Guyana in partnership with ExxonMobil, which won’t reach full production until the mid-2020s and will operate indefinitely thereafter. The industry shows no signs of slowing down.

DeSmog has spent years exposing the bad-faith PR behind the oil industry. The public is increasingly aware of the industry’s obfuscation. But even at this late stage, with the climate crisis worsening and even with the world’s central banks sounding the alarm, the oil industry’s response in Davos amounted to a decision to engage in yet another round of advertising.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.

26 comments

  1. notabanktoadie

    They can also exclude debt of carbon-intensive industries when they purchase bonds, …

    As if a Central Bank has ANY proper businesses buying private assets in the first place since that violates equal protection under the law.

    But hey let’s ignore ethics in our panicky concern about the excess production of CO2 which has its root cause in an unjust finance system to begin with.

    The rest of mankind, who were not killed by these plagues, did not repent of the works of their hands, so as not to worship demons, and the idols of gold and of silver and of brass and of stone and of wood, which can neither see nor hear nor walk; and they did not repent of their murders nor of their sorceries nor of their immorality nor of their thefts. Revelation 9:20-21 [bold added]

    If we can’t even repent of stealing from and oppressing the poor, how can we have any hope for the future if a just God exists? And if He doesn’t exist then what hope is there anyway?

    Reply
    1. Samuel Conner

      The thought has occurred to me that Central Banks could pursue “systemic risk mitigation” policies, which I think are within their mandate, through expansion of “unconventional policy” to include purchases, either directly or though the thin veil of secondary markets, of green infrastructure bonds.

      If the fiscal authorities of major governments do not “step up to the plate”, the monetary authorities may be forced to act.

      Reply
      1. Grumpy Engineer

        Alas, notabanktoadie is correct. Central banks have no business buying private assets. This would include “green infrastructure bonds”. Part of the reason is because of fairness concerns (i.e., the “equal protection under the law” aspect), and part of it is because central bankers are utterly unqualified to determine which green infrastructure projects will actually work.

        Indeed, what should the central banks should fund? High-speed rail in California? Bus routes in rural communities? Small modular nuclear reactors? Solar farms in the middle of forests? Wind farms on top of mountain ridges? Tidal power facilities on coastlines? Giant lithium and cobalt mines? Flywheels? Water electrolysis facilities and hydrogen pipelines? Increased corn ethanol production? Corn farms converted back into forest? Pumped storage facilities carved into pristine mountain sides? A vast new network of high voltage lines to connect all this stuff together? A battery system and new electric car for every household?

        Every single item I listed above has been touted by somebody as beneficial to the environment. Are the economists employed by the central banks qualified to determine which ones would actually help? And do they have enough people to evaluate the tens of thousands of proposals they would get if they suddenly offered to directly fund green infrastructure projects?

        It wouldn’t work. The opportunities for corruption and fraud would be immense, and the environment would see very little benefit. Looking to our central bankers for salvation is a doomed approach.

        Reply
        1. Susan the other

          Only by controlling demand. We can ration the consumption of oil, limiting how much can be pumped/stored. We can ration it by how much can be used – allotment. We can ration it by need – which needs? It cannot voluntary, it will never work unless we replace the convenience of petro energy with another form of energy and that is too gradual a process. But we can make a lifestyle without excessive petro energy doable. Instead of errand running like disorganized nitwits (that would include all of us) we can have deliveries, maybe 5 or 10 per month. Etc. Ration it until we learn how to live without it. And as far as not having the money to mitigate green disasters is concerned – that’s pure nonsense. That’s like imposing austerity upon catastrophe.

          Reply
          1. Grumpy Engineer

            But the central banks can’t buy rationing. All central banks do is print money to buy bonds. I supposed they could try to limit where the money for those bonds goes, but in an ultra-liquid Wall Street environment, it’s awfully hard to keep money from sneaking out sideways for unintended purposes. And if profits in the fossil fuel business are high enough, dollars from Wall Street won’t be needed for continued operations anyway. Rationing is something governments would have to impose.

            And that’s why I agree with notabanktoadie’s objection. Asking central banks to “exclude debt of carbon-intensive industries when they purchase bonds” will do little to help the environment while establishing tactics that will strengthen the worst aspects of capitalism. Giving them authority to decide who gets to borrow money and who doesn’t is begging for abuse and corruption.

            Would rationing help? Perhaps. You can add it to the big list of prospective fixes I posted above. But do you really trust the “economist elite” to make the right picks? I certainly don’t.

            Reply
            1. BlakeFelix

              While not in their current toolset, I think that the right response is to give revenue neutral carbon tax/UBI authority to the central banks and recognize that their current practices drive inequality up. Then optimize social inequality for growth or happiness or something. If things are too equal, less carbon tax more whatever they do all day now, if, as for the foreseeable future things are too unequal or carbon is a threat raise the tax. We should dial it back if we start sequstering too much carbon, but that’s not a near term threat. And UBI is inflationary and taxes are deflationary, so they really naturally belong with currency value control anyway IMO. Not revenue neutral if you want to steer the inflation rate, obviously.

              Reply
            2. Carl Stoll

              Rubbish! What you call “abuse and corruption” is in economic terms called central economic planning. Planners must optimise financial investment. And the reason is very simple. Markets function in the long term as they slither toward equilibrium. But the time for that is over, finished, kaputt! The free market must be dismantled and replaced by central planning, because there is no time to waste. And the first step must be to confiscate the assets of the oil companies.

              Reply
    2. paul

      And if He doesn’t exist then what hope is there anyway?

      Then that we’ve got far enough to think without him (though mother earth might hate your pronoun).Vamos!

      Reply
    3. inode_buddha

      “As if a Central Bank has ANY proper businesses buying private assets in the first place since that violates equal protection under the law.”

      What was it called when J.P. Morgan put up 20 million to create Lackawanna (Bethlehem) Steel in 1890?

      Reply
  2. Lee

    It would seem that there is a growing divergence between providing for our material necessities on the one hand, and meeting the requirements of our profit driven, artificially limited currency based system on the other. Funny how that works. Unfortunately, the the transitional interregnum between systems may prove to be a bitch—with apologies to my sweet tempered pit bull, Lady Barksalot.

    Reply
    1. lyman alpha blob

      +1

      If, and more likely when, things do go pear shaped due to climate change, one of the last things anyone will be worrying about is whether their credit card is working or not.

      The bankers issuing this warning sound like they’d like a pre-emptive bailout for themselves.

      Reply
  3. Mel

    This article sidesteps the Medieval Scholastic issue of adequatio. Are the BIS and all the financial institutions even adequate to act on climage change problems? Their capability is to write numbers in ledgers. Do they have any organs that can touch the physical processes that are changing the earth’s climate?

    I see this as the financial industries’ opening bid. If we don’t play their way, they will withhold their money and let us try to survive. If we play too nicely, they will take the money we spend to reconstruct society and disappear it into Special Purpose Vehicles, off-balance sheet entities and such things. Any systemic risk mitigation measures they can undertake can mitigate only their own risk. Our risks of drowning, or baking, or burning, or going down for the last time in vast prairies of mud aren’t touchable by their means.

    I had wondered for quite a while how financial work can motivate. How can marks on an image, when the marks turn out to be numbers in a financial report, connect with the brain chemicals that mediate human motivation, so that a financier does something? Stumbling and Mumbling On Socially Influenced Preferences looks to have an answer. The information would affect their self-image vis-a-vis other financiers, and hook up with basic social status mechanisms. Maybe I should have seen that before.

    Reply
    1. Jeremy Grimm

      I am not sure what to make of your comment. Financial institutions are quite capable of acting on their risk assessments by demanding higher returns, refusing to invest where risk is too high, and crawling to the government for bailout money when the investments they do make and have made fail. Financial institutions do not care about acting on climate change problems in ways other than serving their own interests.

      Financial institutions already take the money we spend — or more accurately, failed to spend — to reconstruct society and disappear it into Special Purpose Vehicles, off-balance sheet entities and such things. Of course they seek to mitigate their own risks and have no further cares. They have behaved that way for decades — probably more like centuries or millennia.

      The notion of socially influenced preferences falls flat when we are talking about food as one Lloyd’s report discusses. The example from Adam Smith cited in Stumbling and Mumbling — a ‘need’ for linen shirts as a measure of social status pales compared to needs for food, water, shelter differ.

      [Did you really wonder how financial work can motivate? … $$$$$$$$$$ work!

      Reply
    2. BillS

      Veritas est adequatio intellectus et rei…. (Thomas Aquinas) Truth is revealed via the senses, we can come to know things without the need for divine revelation. Aquinas also had quite a bit to say on economic issues as well (theory of value, usury as parasitism, etc.) Dante would later place usurers in the Seventh Circle, not all that far from Lucifer’s Pit.

      I think it is pretty clear that we are on the threshold of a “Great Bifurcation”, so to speak. Many of us know that finance and the War Machine must be reined in and the economic system must recognize that what it once considered externalities are now unavoidable costs that must be taken into account. My hope is that this change can take place in a democratic and peaceful way. My fear is that the Oligarchy will never allow this to happen, paving the way to war, decay and a new Dark Age. In the end, the Oligarchs would risk their own destruction rather than do their part in any renewal of the Social Contract.

      Reply
  4. Jeremy Grimm

    The DeSmog post includes the link to the BIS report:
    “The green swan — Central banking and financial stability — in the age of climate change”
    https://www.bis.org/publ/othp31.pdf
    I am curious how it compares with Lloyd’s London Emerging Risk Reports:
    “The risk of global weather connections”
    “Understanding Risk Evolving Risks in Global Food Supply” and
    “Food System Shock”,
    Lloyd’s Risk Reports were referenced in a post from earlier this year on NakedCapitalism.

    Reply
  5. TH

    The BIS paper is very worthwhile as it illuminates the inherent contradictions in mounting such an awareness and reconfiguration of the financial system. More than anything the paper calls for an “epistemological shift”, in that existing paradigms for thinking about, considering, and measuring climate risk are inadequate.

    This is spot on. Ergodicity and the fallacy of endless economic growth are two central tenets of economic thinking. But neither of these ideologies are addressed in the report! Thus while it acknowledges that massive shifts in perception, thinking and understanding of climate risk are needed, particularly by those responsible for perpetuating the crisis, the report itself remains caught in retrograde frameworks. (While ergodicity it not itself discussed, the paper does emphasize the need for scenario based modeling rather than historically-based probability distributions to model risks.)

    For example, one of the “transition risks” the BIS papers raises, and which the industry continuously talks about, is decreased economic growth. But the obsession with economic growth as a panacea for all social ills is precisely what has fueled the climate crisis to where it is today. Ecological economics’ very origin is based upon the failures of existing modeling frameworks, but these existing tools get little notice in the report.

    Reply
    1. Jeremy Grimm

      I was disappointed after scanning through the BIS paper. I had hoped the BIS paper contained some particular scenarios of risk, like the scenario described in Lloyd’s Report on risks due to Food System Shock. I didn’t spot any scenarios of that sort. The annexes describing various risks make the closest approach to specific scenarios like I hoped to find.

      I was disturbed by some statements in the report: “An important source of technological uncertainty has to do with the role allocated to negative emissions and to CCS technologies.Their relative importance varies widely across models: in a subset of 2°C scenarios, between 400 and 1,600 gigatonnes of carbon dioxide (GtCO 2 ) can be compensated through negative emissions and CCS, corresponding to 10–40 years of current emissions (Carbon Brief (2018)).” The climate papers I read suggest that 800 GtCO2 would be ‘bad’ and 1600 GtCO2 ‘very very bad’ and negative emissions and CCS technologies would be swell … except where are they. The idea of “central banks as coordinating agents in the age of climate uncertainty” — the title of section 4. sounds scary at best. The conclusion waves its hands around this idea. I am not too keen on central banks having any more power [less would be better] or counting on the good offices of central banks in assuming “a role for central banks to be more proactive in calling for broader change” as suggested in the conclusion. I would be happy if central banks were to work toward maintaining financial stability — something they did a poor job of not so long ago. The many uncertainties this BIS paper dances around in annex 2: “Mitigating climate change in order to avoid its worst physical impacts amounts to nothing less than an unprecedented socioeconomic challenge, requiring the replacement of existing technologies, infrastructure and life habits over a very short time frame.” — suggest to me neither central banks nor banks should be messing with financing this stuff.

      I got the impression that the authors of this paper assumed central banks had some role to play in addressing Climate Chaos and its associated risks. I believe the statement from the conclusion section: “no single model or scenario [of climate risks] can provide sufficient information to private and public decision-makers” makes plain this is not an area where finance or banking should be involved. It is very clearly an area demanding the actions of government.

      Reply
  6. Caleb

    How about nuclear power, one of the fake “solutions” offered?
    We taxpayers subsidize that and are left holding the bag at the corporal, personal, private property, state and federal level, in case of meltdowns.

    I will trust nuclear power’s safety when they can buy adequate to potential loss liability insurance on the open market.

    Reply
    1. turtle

      I will trust nuclear power’s safety when they can buy adequate to potential loss liability insurance on the open market.

      That’s an excellent way to think about it. Thanks.

      Reply
  7. drumlin woodchuckles

    When coastal and near-coastal property has been all-the-way un-insurable-ized and totally dehedged-from, parts of the Its A Liberal Hoax community will ramp up their propaganda even louder. That would be the perfect time for coastals and near-coastals who wish to leave the coast . . . to offer their properties and assets at “good prices” to wannabe contrarian investors from the non-coastal regions . . . who wish to place a long term bet on the rising sea level being just a cycle and a phase.

    In all seriousness, we should do all we can to get the Contrarian Investors on board that barge before it sets sail.

    Reply
  8. Sound of the Suburbs

    The BoE forecasts that it will able to raise interest rates next year.
    https://blogs.spectator.co.uk/2017/08/mark-carney-should-stop-blaming-brexit-for-rock-bottom-interest-rates/
    When next year arrives, they can’t.
    It has never occurred to them to think about what might be wrong with their models.

    Don’t load them up with anything else, the central banks are having enough trouble as it is.
    Let them try and work out how the economy operates without climate change problems first.

    Reply

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