'Rapid' low-carbon transition could damage economic stability, warns Bank of England

The transition to a low-carbon economy is filled with potential paradoxes that could lead to either the current generation having no "direct incentive" to drive change, or actually transitioning too quickly to the point where financial stability would be damaged.

That is the view of the Bank of England governor, Mark Carney, who used a speech in Berlin on Thursday (22 September) to highlight the delicate but critical role that the green economy has in boosting monetary stability while also tackling climate change.

“First, the future will be past. That is, climate change is a tragedy of the horizon which imposes a cost on future generations that the current one has no direct incentive to fix,” Carney said. “The catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors including businesses and central banks. Once climate change becomes a clear and present danger to financial stability it may already be too late to stabilise the atmosphere at two degrees.

“The second paradox is that success is failure. That is, too rapid a movement towards a low-carbon economy could materially damage financial stability. A wholesale reassessment of prospects, as climate-related risks are re-evaluated, could destabilise markets, spark a pro-cyclical crystallisation of losses and lead to a persistent tightening of financial conditions: a climate Minsky moment.”

Risky business

Carney noted that at least three risks would be ever-present during the transitional phase to a low-carbon economy. He called on insurers to constantly update and adjust coverage to mitigate physical risks that could lead to “swathes” of the economy becoming “uninsurable absent public backstops”.

Insurers and investors were also urged by Carney to look out for liability risks stemming from companies and parties who have suffered loss due to climate change, noting that climate refuges could pave the way for compensation packages in the future.

According to Carney, another ever-present risk will be what actually occurs during the transition. He noted that changes in policy, and uptake of new technology and physical climate impacts would lead to the reassessment of asset values, with re-pricing becoming “decisive for financial stability”.

He claimed that more than £76trn currently belonging to global investment firms could be funnelled into green bonds, more than double the current estimated £32bn green bond market. The calls echoed the concerns of WWF that new standards would need to be introduced to overcome “complexity and confusion”.

As well as claiming that China’s renewables transition would require around €500bn a year from 2016 to 2020 to finance, Carney also called on the German government to push the low-carbon agenda once it assumes G20 presidency next year.

The risks of Paris

Carney also noted that the “crucial” Paris Agreement – which is primed to come into force this year – was only steering nations towards a global temperature rise of at least 2.7C by 2100, stating that more would need to be done to stretch the goals.

“The world has committed to do something, but not yet enough to meet its stated goals,” Carney added. “Therefore, Paris clarifies actual and stretch objectives. It provides detailed climate policies and creates the prospect of a future ratcheting up of efforts. In doing so, it greatly increases transition risks as well as opportunities. By bringing forward the horizon, it puts a premium on the ability of private markets to adjust.”

Carney has previously warned that around $7trn would need to be spent on new green infrastructure across the globe in order to cut carbon emissions over the next 20 years.

During his speech in July, he noted that only around one-third of the world’s 1,000 largest companies were providing banks and stakeholders with active and effective climate disclosures, and that longer-term strategies were becoming much more important.

Matt Mace