Central Bank Network issues warnings of climate-related financial risks and recommendations for central banks, supervisors and policymakers

By Robin Hamaker-Taylor and Laura Canevari

Members of the Central Banks and Supervisors Network for Greening the Financial System (NGFS) have called for collective action to manage climate-related financial risks. In its first comprehensive report, the NGFS has issued six recommendations; four for central banks and supervisors, aimed at enhancing their role in greening the financial system, and a further two recommendations for policymakers aimed at facilitating the work of central banks and supervisors.

The NGFS brings together 36 central banks and supervisors – representing five continents, half of global greenhouse gas emissions and the supervision of two thirds of the global, systemically important, banks and insurers. The report is the result of the group’s work to identify environmental and climate risk management best practices in the financial sector. Over the last 16 months, the NGFS has found that climate change presents significant financial risks that can only be mitigated through an early and orderly transition.

The six recommendations in the NGFS report consider the distinctive elements of climate change-related financial risks and the need to ensure resilience in finance. They are as follows:

Recommendation 1 – Central banks and supervisors: Integrating climate-related risks into financial stability monitoring and micro-supervision. The NGFS calls on central banks and supervisors to start integrating climate-related risks into micro-supervision and financial stability monitoring. First, this means developing and applying comparable and consistent approaches to assess climate-related risks, such as scenario analysis. The report includes guidance on designing scenario analysis, and suggests that there are two important dimensions to consider when assessing the impact of physical risks and transition risks on the economy and the financial system:

• (a) The total level of mitigation or, in other words, how much action is taken to reduce greenhouse gas emissions (leading to a particular climate outcome), and
• (b) Whether the transition occurs in an orderly or disorderly way, i.e. how smoothly and foreseeably the actions are taken. These two dimensions allow for scenarios to be developed as they present a continuum of different outcomes and transition pathways to achieve them.

The guidance also indicates that further work is also required to translate economic scenarios into financial risk parameters for financial stability analysis, and that financial institutions should not delay their own analyses while central banks work out scenario analysis guidance. Second, this recommendation means integration of climate-related factors into prudential supervision and the report sets out a high-level 5-step framework for this, starting with awareness raising.

Recommendation 2 – Central banks and supervisors: Integrating sustainability factors into own-portfolio management. The NGFS encourages central banks to lead by example in their own operations. Without prejudice to their mandates and status, this includes integrating sustainability factors into the management of some of the portfolios at hand (own funds, pension funds and reserves to the extent possible).

Recommendation 3 – Central banks and supervisors: Bridging the data gaps. The NGFS recommends that the appropriate public authorities share data of relevance to Climate Risk Assessment (CRA) and, whenever possible, make them publicly available in a data repository. The NGFS sees merit in setting up a joint working group with interested parties to bridge existing data gaps. The deliverable of this group would be a detailed list of data items that are currently lacking but which are needed by authorities and financial institutions to enhance the assessment of climate-related risks and opportunities – for example, physical asset level data, physical and transition risk data or financial assets data. The report recognises that important challenges around data remain, including data availability, time horizon, and lack of expertise. The NGFS also indicates it is ready to initiate work with interested parties on setting out the list of currently lacking data items.

Recommendation 4 – Central banks and supervisors: Building awareness and intellectual capacity and encouraging technical assistance and knowledge sharing. The NGFS encourages central banks, supervisors and financial institutions to build in-house capacity and to collaborate within their institutions, with each other and with wider stakeholders to improve their understanding of how climate-related factors translate into financial risks and opportunities. The NGFS therefore encourages central banks, supervisors and financial institutions to:

• allocate sufficient internal resources to address climate-related risks and opportunities;
• develop training to equip employees with the necessary skills and knowledge;
• work closely together with academics and think-tanks to inform thinking; and
• raise awareness by sharing knowledge within the financial system.

The NGFS also encourages relevant parties to offer technical assistance to raise awareness and build capacity in emerging and developing economies when possible.

Recommendation 5 – Policymakers: Achieving robust and internationally consistent climate and environment- related disclosure. The NGFS emphasises the importance of a robust and internationally consistent climate and environmental disclosure framework. NGFS members collectively pledge their support for the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD recommendations provide a framework for consistent, comparable and decision-useful disclosure of firms’ exposures to climate-related risks and opportunities. The NGFS encourages all companies issuing public debt or equity as well as financial sector institutions to disclose in line with the TCFD recommendations. The NGFS recommends that policymakers and supervisors consider further actions to foster a broader adoption of the TCFD recommendations and the development of an internationally consistent environment disclosure framework. This includes authorities engaging with financial institutions on the topic of environment and climate-related information disclosures, aligning expectations regarding the type of information to be disclosed and sharing good disclosure practices.

Recommendation 6 – Policymakers: Supporting the development of a taxonomy of economic activities. The NGFS encourages policymakers to bring together the relevant stakeholders and experts to develop a taxonomy that enhances the transparency around which economic activities (i) contribute to the transition to a green and low-carbon economy and (ii) are more exposed to climate and environment-related risks (both physical and transition). Such a taxonomy would:

• facilitate financial institutions’ identification, assessment and management of climate and environment-related risks;
• help gain a better understanding of potential risk differentials between different types of assets;
• mobilise capital for green and low-carbon investments consistent with the Paris Agreement.

Policymakers would thus need to:

• ensure that the taxonomy is robust and detailed enough to (i) prevent green washing, (ii) allow for the certification of green assets and investments projects and (iii) facilitate risk analysis;
• leverage existing taxonomies available in other jurisdictions and in the market and ensure that the taxonomy is dynamic and reviewed regularly to account for technological changes and international policy developments;
• make the taxonomy publicly available and underline the commonalities with other available taxonomies. Eventually, it should strengthen global harmonisation to ensure a level playing field and prevent the dilution of green labelling.

Together this network of central banks has sent a powerful signal – that climate change presents significant financial risks that can only be mitigated through an early and orderly transition. Mark Carney, governor of the Bank of England, Banque de France governor Villeroy de Galhau, along with NGFS chair Frank Elderson, board member of De Nederlandsche Bank issued a stark warning about the financial risks of climate change last week in an open letter alongside the NGFS report. Published on the same day as the report, the letter calls for ambitious and collective leadership across countries, in order to ensure the stability of the wider financial system in the face of climate change.

The NGFS will now work to enable an orderly transition by supporting the development of additional resources, including a handbook on climate and environment-related risk management for supervisory authorities and financial institutions, voluntary guidelines on scenario-based risk analysis and best practices for incorporating sustainability criteria into central banks’ portfolio management.