Australia's Financial System and Climate Risk Discussion Paper

Jul 13, 2015 - 12:01am

Numerous authorities, including governments, regulators, central banks and supra-national bodies have decided that this is a question deserving formal investigation.

In Australia, there has been no official examination of how climate change might affect our financial system. Yet an 0.9°C observed increase in Australian average temperatures since 1910 has already been directly linked to increasingly frequent and intense heatwaves, and is likely linked to changing rainfall patterns observed in recent years.

This paper explores where characteristics of Australia’s own financial system may intersect with identified risks relating to climate change. It highlights areas where existing financial system safeguards may not address these specific and
unique risks.

Drawing on studies and regulatory decisions from overseas and Australia, we set out why climate change deserves careful consideration from authorities charged with maintaining financial system stability.

Key points

Broad categories of climate financial risk:

  • Carbon risk, which includes financial exposure to the risk of carbon emissions or carbon-intensive assets being priced, regulated, stranded by technology, or incurring legal risk
  • Climate impact risk, where assets are damaged or devalued as a result of climate change itself

How climate risk may originate:

  • Efforts to avoid climate change, including domestic, foreign and international policy measures
  • Shifting demand for carbon-intensive exports
  • Shifting investor appetite for carbon intensive assets
  • Fiscal risk from unfunded public contingent liabilities arising from the effects of climate change
  • Uninsured or uninsurable assets exposed to increasingly probable catastrophic disasters
  • Individuals and institutions are incentivised to ignore risks

Points of transmission and amplification:
How the effects of climate risk may magnify and spread throughout Australia’s financial system. These include:

  • Australian sovereign debt, if affected by factors including macro outlook changes due to our carbon-intensive economy (carbon risk); and fiscal position shifts due to our exposure to climate change itself (climate impact risk)
  • Exposure of Australian banks to carbon intensive assets via their business loan books (carbon risk)
  • Exposure of Australian banks and parts of the insurance sector to climate impacts via their concentration in residential property & mortgage debt (climate impact and carbon risk)
  • Exposure of large superannuation (pension) asset pools, due to concentration in domestic assets of a carbon-intensive, climate impact-exposed economy (carbon risk and climate impact risk)
  • Shortage of low-carbon assets potentially leading to over-inflation of such assets

Information barriers and opacity:

  • Scientific climate models are subject to uncertainty; however this is improving
  • Information is unevenly distributed, with some key financial agents lacking visibility of climate risk which may expose them to loss
  • Both public and private disaster mapping data and modelling is unco-ordinated and difficult to access
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