REMARKS BY JAVIER GUZMÁN CALAFELL, DEPUTY GOVERNOR AT THE
BANCO DE MÉXICO, AT THE PANEL ON "DEVELOPING SUSTAINABLE CAPITAL
MARKETS: MAPPING THE CHALLENGES AND SETTING PRIORITIES". OMFIF-
DZ BANK, Washington, DC, October 19, 2019.1
I thank the organizers for the invitation to participate in this panel.
Mainly as a result of increasing carbon dioxide and other greenhouse gas
emissions that have come about as a byproduct of economic activity at large,
but particularly in sectors heavily reliant on fossil fuels, global temperatures
are at present higher relative to pre-industrial levels, and are projected to rise
further in coming decades. In addition to the environmental, health and
broader welfare costs that such damage is already impinging, climate-related
risks are among the main threats faced by the world in the medium- to long-
run, especially in view of scenarios with potentially catastrophic and
irreversible consequences, which are currently envisaged as plausible.
Given the complex and multidimensional nature of the issue at hand, as well
as the extensive and, to a significant degree, unknown ramifications that may
ensue, any sensible proposal with realistic chances to effectively contribute to
a solution must contemplate the simultaneous and coordinated action of
diverse, albeit complementary, policy tools. In addition, even though unilateral
efforts at the domestic level are essential, international cooperation is needed
to successfully overcome these challenges.
Why is the involvement of central banks in these issues important?
To start with, climate change is expected to have substantial macroeconomic
consequences in coming decades, as it will adversely affect output in a number
of sectors. The most severe impact will fall on climate-sensitive sectors, such
as agriculture, forestry, coastal real estate and tourism. This may also be
reflected on global inflation, to the extent that agricultural and other prices
fluctuate more widely, as a result of more frequent and more severe extreme
weather events. It is also worth noting that although vulnerabilities vary across
countries, those that will likely be most exposed to these risks are among the
group of developing economies, in view of the sectoral composition of their
GDPs, their geographical location, their poverty levels and a more limited
capacity to adapt.
Average estimates of the impact of a 3 degrees Celcius increase in world
temperatures point to a 2 percent decline in potential global GDP by the end
of this century.2 However, these estimates are surrounded by considerable
uncertainty. In addition to the complexities of modelling and calculating the
impact of climate change on the environment and then on the economy, most
of them are based on historical data, and do not consider neither extreme
events nor the potential non-linearities that could substantially accentuate the
economic consequences of climate change. In this respect, it is worth to
mention, for instance, the migration pressures and conflict risks that could
derive from global warming.
A proper consideration of the consequences of climate change is also
important for central banks in view of their implications for the financial
sector. Beyond those related to the above-noted macroeconomic
consequences, this has two dimensions.
On the one hand, at the microprudential level, central banks and other
financial authorities ought to undertake a continuous and careful evaluation
and monitoring of the risks for individual financial institutions deriving from
their exposure to assets, projects, entities and/or income streams that are
directly affected by climate-related developments. Efforts have been carried
out in this regard both at the national level and internationally through
institutions such as the Financial Stability Board and the International
Association of Insurance Supervisors.
However, this process is only in its early stages and more work is needed in a
number of areas. For instance, climate change scenarios are not typically
considered in financial sector stress testing. Furthermore, action is needed to
ensure that financial institutions incorporate environmental scenario analysis
into decision making, and to support this process through a more active
disclosure of data on the environmental sources of risk for the financial sector
and a better understanding by regulators both of these risks and the tools
needed to face them.
Due to their potential magnitude and overarching scope, possibly amplified by
ensuing market responses, climate-related shocks to individual financial
institutions may easily propagate and give rise to system-wide disruptions.
Therefore, climate change also poses financial stability risks, an issue
incorporated in the mandate of many central banks. As a result of the apparent
long-term characteristics of these risks, and insufficient awareness both
among investors and financial institutions of the climate-related nature of
some of their assets, they rarely incorporate them in their risk management
frameworks. Under these circumstances, the potential for contagion and
market disruption resulting from a climate shock may be substantial.
Assuming that these risks will materialize only in the long run is mistaken. For
instance, losses for insurance companies as a result of climate-related events
are today almost 10 times larger than the average observed during the 1980s.3
Moreover, an evaluation of these risks is extremely complex, and more so in a
context of the existing data constraints. Therefore, major efforts will still be
needed to develop a set of data, indicators and models that can allow a proper
assessment of the financial stability implications of global warming. Increased
disclosure of firms' carbon footprints, prudential requirements for the
insurance sector, addressing possible misalignments within financial
regulation and practices, and the use of financial instruments that reduce and
better allocate climate-related risks would also enhance financial stability in
the transition to a low-carbon economy.
On the other hand, the investment needs to hold the increase in global average
temperature below 2 degrees Celsius relative to pre-industrial levels are
substantial. According to recent estimates, some additional USD 600 billion per
year will be needed, on average through 2030, in order to keep infrastructure
investment across transport, energy, water and telecom systems consistent
with the above-noted limits on global warming. This is on top of the resources
required in these areas to sustain growth and meet the basic population
needs, estimated at around USD 6.3 trillion per year during this period.4 The
challenge will be how to finance needs of this scale.
Clearly, financial markets can help to meet this goal, by increasing the capital
channeled to these projects. In particular, with financing requirements
significantly exceeding the resources available through the banking and
corporate sectors, the need for a major role of bond markets is underlined. In
this context, although not unilaterally, but rather in coordination with other
authorities and stakeholders, central banks have a role to play. Green finance
has grown substantially in recent years, but there certainly is ample potential
for further development as significant gaps vis-à-vis the resources required for
the fulfillment of international commitments on the matter remain. With this
purpose in mind, a number of actions and strategies can be harnessed.
Among these, it is worthwhile noting that notwithstanding the significant
progress achieved over the last years in terms of the definition, standards and
best practices in relation to green activities and finance, additional efforts in
this direction are needed, with particular attention towards their improved
adoption, compliance and monitoring. Naturally, more transparency and
clarity regarding the projects that are being financed, as well as the associated
risks, would result in increased confidence and, thereby, interest from the
broad investor community. Importantly, this would also help overcome
important barriers for institutional investors who, owing to their more strict
criteria and requirements, may have been impeded to resort to this type of
instruments due to insufficient visibility of the projects and activities to which
resources are being channeled. Additional barriers for the development of the
green bond market are the absence of a developed domestic debt capital
market and the insufficient number of bankable and standardized green
projects.
Closely related to the above, significant efforts must still be made in order to
bridge remaining data gaps.5 The better equipped investors are to more
accurately assess returns and risks associated to green financial instruments,
the more likely they are to partake. To this end, central banks and other
authorities, not exclusively in the financial sector but perhaps also in the
environmental and related realms, must join efforts to gather, generate and
publicize relevant, dependable statistics of trusted quality.
More directly, central banks themselves can "lead by example", specifically by
evaluating the possibility to systematically incorporate sustainability
considerations as part of their portfolio allocation decision process. The
potential for action in this front is ample, in view of both the amount of
financial resources (i.e. international reserves) managed by these institutions,
on the one hand, and the still-low extent to which they take action along these
lines, on the other. For instance, in a recent BIS survey, nearly two thirds of the
respondents answered "no" to the question "Does your central bank include
sustainability considerations in the pursuit of its policy objectives?".6 An
increased demand by central banks of green bonds may have the added
benefit of contributing to the development and a more generalized adoption
of standards and best practices in this market. Naturally, it is also important to
consider that investment in green bonds by these institutions is not free of
constraints such as, for instance, those related to accessibility and liquidity.
Lastly, and rounding all this up, it is important to raise awareness and help
develop the sense of commonality required to achieve greater adherence to a
collective strategy. To this end, sustained collaboration among all relevant
parties geared towards capacity building and knowledge sharing is essential,
while the establishment of frameworks conducive to the wider diffusion and
disclosure of the issues and actions undertaken, including to the general
public, further adds to these objectives.