Climate change to pose risks to financial systems: MAS

Financial systems will be vital in enabling economies to make a successful transition to a more sustainable trajectory.
Financial systems will be vital in enabling economies to make a successful transition to a more sustainable trajectory.ST PHOTO: KUA CHEE SIONG

SINGAPORE - The Covid-19 pandemic, which has reduced the earnings of many companies and the incomes of numerous households, dominates daily news.

Yet there is another long-term event that continues to present significant risk to financial systems and their customers, and that is climate change, said the Monetary Authority of Singapore (MAS) in its annual Financial Stability Review that was released last Tuesday (Dec 1).

To address this, regulators and financial institutions need to assess how climate change will impact them, the authority added, noting that there is growing recognition of the risk to such attached to sustainability-related issues.

"Climate change has become the defining challenge facing both present and future generations. From shifting weather patterns to rising sea levels, the risks posed by climate change are both multi-faceted and pervasive in their manifestation," it said.

"The financial system plays a key role in catalysing this global response. Financial markets are pivotal in the allocation of capital and resources throughout the wider economy."

It added that the financial system will be vital in enabling economies to make a successful transition to a more sustainable trajectory.

"At the same time, financial institutions are exposed to climate risks because they provide financing and insurance services to entities which could be significantly impacted," it added.

Climate change leading to environmental crises can pose physical risk to companies. People and firms can face costs and losses when exposed to such disasters, MAS said.

These crises can range from flash floods to longer-term changes in climate patterns, such as the gradual melting of polar ice sheets and desertification, where once-fertile areas become arid and in danger of losing water, vegetation and wildlife.

But climate issues can also have wider macro-economic effects, MAS said.

For instance, a country whose key infrastructure is destroyed by the crisis can also see its stocks being impacted and productivity hindered, if workers are impeded from performing their tasks.

In addition, climate change poses transition risk to companies, according to the authority.

This refers to how the switch to a low-emissions economy can create economic uncertainty and incur financial costs for firms as they try to adjust to new policies, investor preferences and social norms.

Firms that have a greater dependence on carbon-intensive assets can be more badly hit, MAS said.

"Conversely, firms with more environmentally-friendly processes might stand to benefit."

These climate-related risks can have implications on financial systems, it noted.

For instance, a borrower will be less able to repay debt if he is affected by climate crises. Devaluation of a borrower's assets can also lead to higher credit risk for banks.

Market prices can also take a hit, the report said, especially for those firms related to carbon-intensive industries and commodities.

New green technology can eventually render some businesses obsolete, with shifts in consumer preferences, it noted.

Investors have to keep a keen eye on these changes as well, as greener industries might see increases in market value.

"These changes in financial valuations pose market risk to investors, depending on their trading and investment positions," MAS said.

Insurers are also not spared, as they could face large underwriting losses if there are sustained or cumulative claims related to climate disasters.

MAS noted that it has already started to incorporate climate risk scenarios as part of an annual industry-wide stress test.

In the 2018 test, insurers were subjected to a scenario featuring extreme flooding and had to consider the impact of higher claims on their balance sheets.

Within the next two years, MAS will also incorporate a broader range of climate risks in thematic scenarios as part of the test, it said.

"Many of these risks are complex, and assessing them will require the necessary data, expertise, and models. It is thus imperative for the financial industry to build up these resources in a timely manner, in order to better assess, manage and mitigate them."