We’ve all heard of black swan events, a metaphor that describes an event that comes completely out of the blue, left of field, that has severe financial consequences. Now, according to the Bank for International Settlements (BIS), there is a new colour swan we need to be worried about; green. In a paper titled ‘The Green Swan’ it warns that climate change could unleash ‘potentially extremely financially disruptive events’ and as a consequence trigger the next global financial crisis and maybe even cause a more unpredictable chain reaction. In an effort to mitigate the fallout from such an event, the IBS is calling on coordination between regulators, central banks and supervisors. Luiz Pereira da Silva, the BIS deputy general manager, believes such moves are necessary due to the fact that ‘Traditional approaches to risk management consisting of extrapolating historical data and on assumptions of normal distributions are largely irrelevant to assess future climate-related risks’.
The paper, published with the growing acknowledgement of the effect the human race is having on the environment, adds to the growing calls for all bodies to be better prepared for any finance-related risks stemming from the effects of climate change. As Francois Villeroy de Galhau, the Bank of France Governor put it ‘in order to navigate these troubled waters, more holistic perspectives become essential’.
On the face of it the BIS is right to highlight the risks, advising the great and good to jettison what it believes are backward-looking risk assessment models that are not fit for gauging the far-reaching consequences of climate disruptions. With the number of extreme weather events having increased fourfold over the last 40 years, the warning signs are there. As an idea of how some are so ill prepared going forward, in Asia only 8% of financial losses caused by extreme weather events are covered. In Africa, it’s just 3%.
The idea of climate-related risks scenario is not new (although I think the green swan bit is), with many central banks already monitoring environmental risks though a number of different stress tests, with some better prepared than others. However, Villeroy still thinks it’s not enough, believing that ‘The stark reality is that we are all losing the fight against climate change’, adding that ‘If central banks are to preserve financial and price stability in the age of climate change, it is in their interest to help mobilise all the forces needed to win this battle’.