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RBA flags substantial risk of climate change to financial system

By Maja Garaca Djurdjevic
 — 1 minute read

Physical and transitional risks stemming from the climate crisis could have a systematic impact on the Australian financial system, the Reserve Bank warned in its latest analysis.

The paper, which outlines preliminary estimates of the possible scale of climate exposure facing Australian banks, the RBA estimated that if left unmanaged, climate change could spell real trouble for the local financial system.

The RBA explained that mortgage exposure to climate physical risks could result in substantial credit losses. The central bank’s calculations estimate an increase in the dwellings with a value at risk (VaR) rating, or at “high risk” properties, to 8 per cent, from the current 3.5 per cent, over the next 80 years.

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Moreover, the bank found that a VaR change of only 0.4 percentage points is equivalent to roughly a 10 per cent decline in housing prices.

“Banks lend using the current value of housing as collateral. If current values do not fully reflect the longer-term risks of climate change, housing prices could decline, leaving banks with less protection than expected against borrower default,” the RBA cautioned.

It pointed to international studies, many of which have indicated that there is little evidence of climate change being fully priced into “at risk” properties, even in highly vulnerable areas.

“As a result, the price of properties considered to be at ‘high risk’ of being affected by climate events could decline sharply and banks could experience significant credit losses if borrowers default,” it said.

But the bad news for banks doesn’t stop there, with the central bank noting they could be in harm’s way as a result of their lending to businesses that are exposed to transition climate risk.

“This risk is likely to be broadly proportionate to the emissions intensity of each industry they lend to – whether those emissions are from the industry itself or indirectly through the industry’s supply chain,” it said.

“As Australian industries look to transition towards cleaner production methods, the level of disruptions to the banking system will directly depend on the size of exposures banks have to these emissions-intensive industries. If this proves to be material, it could have systemic consequences for the resilience of banks.”

The largest risks to banks, it judged, come from industries like electricity, agriculture and oil and gas, reflecting that these industries have both relatively high emissions and that banks have reasonably sizeable exposures to them.

“The considerable uncertainty about the exact magnitude of the impacts from climate change makes it essential that banks further integrate climate risk into their mortgage and business lending processes and report on it to enable external assessment of the risks,” the bank said. 

In a similar study undertaken by the European Central Bank, data pointed to a high threat of climate change to banks in southern Europe, with defaults on bank loans said to increase by 7 per cent over the next 30 years if nothing is done to limit climate change.

The ECB, however, shed light on the clear benefits that firms and banks would see if they move towards adopting green policies early on to foster the transition to a zero-carbon economy.

 

RBA flags substantial risk of climate change to financial system
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