Bank of Canada Review Declares Climate Risk to Financial System, Wider Economy

The Bank of Canada cites climate change as a risk “to both the economy and the financial system” in its 2019 Financial System Review (FSR), the first in the annual series to examine the climate crisis as a threat to the country’s financial stability.

Potential impacts “include physical risks from disruptive weather events and transition risks from adapting to a lower-carbon global economy,” the Bank states. “Economic activity and the environment are intertwined.”

But years after outside analysts began asking the bank for this type of assessment, there’s concern that Canada has some catching up to do. The global Network for Greening the Financial System launched in 2017, but the Bank of Canada announced only two months ago that it would join.

“And so for two years, Canada has been absent from that international discussion,” said Kevin Quinlan, a responsible investment consultant and former chief of staff to then-Vancouver mayor Gregor Robertson. “Countries that have very different economies than Canada’s are really setting the agenda,” he told CBC News, “and that’s a real disadvantage for Canada.”

“We’re still at the very beginnings of modelling the impact of climate change on the economy,” and “the Bank should obviously have a leading role in that,” added Céline Bak, president of Analytica Advisors and a senior associate with the International Institute for Sustainable Development. “When the Bank of Canada speaks, people listen.”

In March, when the bank announced its decision to join the Network and committed to including climate risk in its FSR process, Governor Stephen Poloz made similar points. “The importance of climate-related issues for financial stability and monetary policy (has) become increasingly clear,” he said at the time. “This is particularly true for Canada, where resources play a vital role in our economy and where the natural environment is a defining feature of our national identity.”

CBC notes that the shift to a low-carbon economy will affect Canadian companies tied to the fossil industry as government regulations tighten up, and pension funds and individual investors cleanse their portfolios. “Even if Canadians continue to invest as they do now, they can’t make informed decisions about the security of those investments if they don’t know the degree to which their investments are exposed to the costs of climate change.”

“Just getting the discipline within mainstream financial statements (on) what the impact of climate change is going to be on the company, and what the company’s impact on climate change is, should be a minimum standard,” Bak said, noting that transparency is the cornerstone of a well-functioning financial market.

But even now, climate risk reporting is not mandatory in Canada. “Any financial reporting that a company does has to be audited. None of that exists with climate disclosures,” environmental and social governance (ESG) specialist Hugh Smith of London- and New York-based Refinitiv told CBC. “Companies highlight what they’re doing well. It tends to be very overly optimistic.”

In its FSR release this week, the Bank of Canada placed climate change fifth in a list of six vulnerabilities facing the economy—ahead of “rapid change in crypto-asset markets”, but behind household debt, an imbalanced housing market, cyber-threats in the financial sector, and fragile corporate debt financing in some parts of the economy.

“Both physical and transition risks are likely to have broad impacts on the economy,” the Bank stated. “Moving labour and capital toward less carbon-intensive sectors is costly and takes time. Global trade patterns may also shift as production costs and the value of resources change. The necessary adjustments are complex and pervasive and might lead to increased risk for the financial system.”

It added that “limited understanding and mispricing of climate-related risks could potentially increase the costs of transitioning to a low-carbon economy. The risks faced by the financial system from climate change can be managed most effectively when investors and authorities know what exposures firms face and how they are being managed.”The FSR release came less than a week after the United Nations warned that delayed action on climate change could cost companies about US$1.2 trillion worldwide by 2030.