Canadian banks start doing the math on climate change risks

Bank of Canada working with financial sector to get a grip on how climate change scenarios will affect their bottom line

Bank of Canada headquarters

At long last, Canada may have reached the point where climate change is no longer a political issue, but rather a clear problem that needs to be solved.

As evidence, take Tiff Macklem. Appointed last June as the 10th governor of the Bank of Canada, his job is to ensure the stability of Canada’s financial system. With the bank’s tradition of political independence, and most of his seven-year term still to come, Macklem can afford to confront the climate threat head-on. 

In a November speech, Macklem declared that “climate change and the transition to low-carbon growth will have profound impacts on virtually every sector of the economy ... so we need to understand the implications of climate change for economic growth and inflation.”

Politicians can trade barbs about climate issues, but financial institutions, as stewards of other people’s money, work hard to mitigate financial risks. “Transition risks are often mispriced, and physical risks are generally underappreciated,” Macklem noted. By filling in that knowledge gap, we could save billions in damage and eliminate an existential threat to Canada’s financial stability. 

The 2008 financial crisis pushed climate issues into the background. But the current pandemic, says Macklem, has “focused the public’s attention on extreme global risks and the value of resilience.” A key indicator is the flow of money into ESG funds – portfolios of equities or bonds that prize environmental, social and governance goals equally with profit. According to Macklem, ESG funds in 2020 raised twice as much money as in 2019, which itself tripled the 2018 amount. Canadian ESG issuance has also jumped, Macklem noted, from less than $2 billion in 2017 to almost $13 billion by mid-November.

To get ahead of the climate crisis, Macklem says the Bank of Canada is developing a multi-year research plan focused on climate risks to the macroeconomy and the financial system. It's also collaborating on transition-mitigation strategies and sustainable finance with global partners such as the International Monetary Fund, the Financial Stability Board, and the Paris-based Network for Greening the Financial System. It’s essential, says Macklem, to be “in the room where it happens.”

And finally, the BoC is "working to bring this analysis home to Canada," Macklem notes. In November, the Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI) announced a pilot project working with a few bank and insurance company volunteers, such as TD, RBC, Manulife and The Co-operators. They'll be developing climate scenarios that will help financial institutions better understand their climate risks under changing conditions. The Bank and OSFI will publish a report, planned for the end of 2021, sharing details on the specific scenarios, methodology, assumptions and key sensitivities.

In a statement, Jeremy Rudin, superintendent of OSFI, said, “Everyone, including the financial sector, will have to adjust to the new reality of climate change. The shape of that new reality will depend on many complex issues and on much that remains uncertain. This pilot project will allow us to refine our focus on the prudential aspects of climate change.”

Knowledge and transparency are power tools, Macklem says: “Scenario analysis will help financial institutions better understand their exposures to transition risks, and this will increase their confidence in their ability to disclose them.”

Then even the politicians will have to pay attention.

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