Central banks of Canada and Mexico move on climate in sign that topic remains priority for supervisors

Amendment: A carbon pricing estimate from the Bank of Canada has been corrected in this article from "around $600" to "around $400". 

 The Bank of Canada (BoC) has published climate scenario analysis of the global economy using an underlying economic model which has not been used for this purpose before.

In a paper published yesterday, the BoC noted that “the current suite of central bank economic models…do not incorporate climate-change effects”.

To address this, BoC utilised a “climate-economy model” which it said is capable of capturing interactions between all sectors of the economy, while accounting for technological advances in production. The model, which is developed by the Massachusetts Institute of Technology, is commonly used to explore the costs of climate-change mitigation.

Climate scenario analysis, one of the recommendations of the Task Force on Climate-Related Financial Disclosures, explores the risks of climate change to financial or economic performance, by modelling the potential impacts of different ‘scenarios’ such as the introduction of a higher carbon price by policymakers or an increase in climate-related weather events.

BoC focuses on transition risk, using four scenarios: 

1. ‘Business-as-usual’, in which no further action to limit climate change is taken

2. A scenario in which countries meet their Nationally Determined Contributions (NDCs) 

3. A scenario where countries act now to limit global warming to 2°C by 2100 

4. And a scenario where countries act from 2030 to limit global warming to 2°C by 2100.

It is important to note that meeting the current NDCs is still insufficient to limit global warming to 2°C by 2100. 

The BoC estimated that delaying climate action until 2030 would require a carbon price of over $600 per metric tonne in 2050 to limit warming to 2°C, while immediate action would result in a carbon price of around $400. Under the scenario where countries meet their NDCs, carbon prices rise to nearly $200, although further increases will be required to meet the 2°C limit.

Summarising the study’s results, the BoC said that a delayed response to climate change is consistent with an “extreme structural transformation of the economy with the largest sectoral shifts and GDP declines” over a short time period. This scenario was also found to result in the most drastic tapering of supply within global oil markets, and an “increased risk of stranded assets” compared to the other three scenarios.

The paper noted that climate-related risks are of “particular concern” to Canada due to its reliance on energy and carbon-intensive sectors. As a net exporter of energy products, Canada is also vulnerable to changes in the policies of its trade partners.

Currently, the BoC is working on developing Canada-specific scenarios to conduct its own climate stress test of the country’s financial sector and to inform monetary policy.

Earlier this month, it was confirmed that the bank would reappoint its former Deputy, Tiff Macklem, as Governor. In his time away from the Bank of Canada, Macklem was one of four individuals appointed by the Canadian Government to advise it on sustainable finance – and he was the central bank's deputy under climate champion and TCFD creator Mark Carney – so there is an expectation that the bank will step up further on climate risk under his leadership. 

Meanwhile, Banco de México has worked with UNEP Inquiry on a report which finds that most financial institutions in Mexico are unfamiliar with the TCFD. In a first-of-its-kind study, Mexico’s finance sector is analysed for its readiness to address environmental and climate risks. A survey of 66 organisations in the country found 70% of banks and 85% of asset owners are unfamiliar or have just started learning about the TFCD. It also finds only half of financial institutions consider that environmental risks can impact them financially. The report recommends a taskforce led by Banco de México and other financial authorities to mobilise climate and SDG finance and create a sustainable finance taxonomy.

The studies indicate that, despite coming under fire for not incorporating climate considerations into COVID-19 stimulus package, central banks still have sustainability and climate change on their radars. Dutch central bank DeNederlandscheBank and the Bank of England are among the leaders on the topic, while green central banking body the Network for Greening the Financial System has confirmed it is working on an analytical framework to test for climate-related transition risks in the euro area banking sector.

 

Additional reporting by Vibeka Mair