• Financial institutions operating within the ASEAN region should consider the impact of policy options that ASEAN central banks shared in a new Task Force report
  • These policy considerations should be integrated into their climate scenario analysis & planning in order to create better outcomes

Climate- and weather-related disasters have increased in number over the past half century and the pace has accelerated over the past 30 years. The IFRC World Disaster Report 2020 has highlighted some key statistics and called for a more equitable response focused on the most vulnerable. From a humanitarian perspective, there is a strong case for both climate change mitigation and adaptation efforts. The humanitarian issues posed by climate change may also reinforce the ratchet affecting policy and central bankers’ responses. If this happens, it could more closely align economic, financial stability and humanitarian considerations in climate action.

With over 20% of the global population now having experienced some weather- or climate-related disaster in the last 10 years, the risks from climate change are no longer theoretical for most people. Climate scientists have outlined the future prospects if no action is taken, where the disasters become larger and have a wider impact and cause significant economic disruption. Even where robust action is taken, the impact of climate change will become a source of both chronic and acute economic shocks for the foreseeable future.

A new report released by the Task Force on the Roles of ASEAN Central Banks in Managing Climate and Environment-related Risks sets out the constraints and options available for the region’s central banks. It is useful for ASEAN-based financial institutions’ strategy development because it makes explicit some of the assumptions and constraints that central banks are operating under. This can provide some guide into how their policies will evolve in response to various climate scenarios in the future.

It also serves as a relevant source of information about possible future central bank policy responses across emerging markets with similar economic characteristics as those in the ASEAN region, and shows the scale of the impact that climate change is having. For example, the report cites research about the risk exposure that climate change poses to the ASEAN region.

“Under a simulated scenario of 4 degrees Celsius global warming, ASEAN potentially faces severe damage, with loss estimated at US$4.16 trillion per year up to the year 2100.” (Task Force report)

Beyond the humanitarian disaster of climate change, the economic risks are large enough to compel action. Although ASEAN central banks have shown some reticence in taking a leading position using their monetary policy tools, they have many levers to influence the financial sector, and an awareness that they will need to act. The rationale they provide for action, coupled with the ongoing economic and humanitarian impacts of climate change, provide some guidance for financial institutions looking to anticipate what types of policy changes are likely in the future.

Each of the ASEAN member countries’ central banks operates under a slightly different mandate, but common among most is to target monetary and financial stability. Climate change will affect both with varying degrees of uncertainty. For example, physical risks may be relatively localized, temporary if acute, and influence short-term inflation and growth rather predictably. Transition risks, on the other hand, could have different impacts depending on the time horizon considered.

The process of internalizing greenhouse gas emissions could create short-term inflationary pressures while depressing medium-term growth, which makes a monetary response more challenging. Central bank independence and market neutrality (central banks maintaining economic & financial stability without affecting resource allocation) are two of the pillars of their operations that could be challenged if their policy changes precipitate this process. One point of ongoing debate in central banking is whether market neutrality is appropriate if it exposes central banks to climate-related risks, if the market-neutral portfolio leads asset purchases towards more polluting sectors.

ASEAN central banks see their mandate for unilateral action as stronger in protecting financial stability. Within this space, they have several options for action (see table below). These policies can be categorized as supervision-related to ensure that climate-related risks are properly accounted for and market facilitation to promote greater uptake of green finance.

For financial institutions, this provides a starting point for the regulations to anticipate in scenario analysis based on the likelihood that regulators will take, have taken or could step up existing regulations in response to climate-related changes. Returning to the start of this article, the scenario analysis should be designed to reflect the widespread impact that climate- and weather-related disasters have had.

The more that people are personally affected by climate-related disasters, the more likely sentiment will change towards stronger action at the policy-maker level, which will influence the speed at which central banks move through their menus of policy responses. This feedback loop complements the Paris Agreement ‘ratchet’ mechanism, which itself is designed to amplify movement on climate-related risks, particularly in the 2023–2025 period. This Inevitable Policy Response can be taken as a given, although the specific policies to be implemented will vary by country and are unknown today. The role of climate-related disasters will only serve to accelerate this response.

The realization of the policy response is likely to significantly accelerate within the next 2–4 years, and it could be sooner. The expected time period for the stepping up of central bank policy on climate-related financial risks is well within the planning horizon for financial institutions. If they have not already been, they will be called on by shareholders and regulators to develop, disclose and fully implement their own plans for managing climate-related risks.

For those in the ASEAN region, the central banks’ menu of policy responses is quite clear. In other emerging markets, the policy choices will be informed by the monetary policy mandate but will likely draw from a similar range of options. Unmitigated climate change will override financial institutions’ efforts to promote social responsibility. For every financial institution, this should be a call to action that their response to climate change presents an opportunity to contribute towards significant economic, financial stability, and humanitarian benefits for themselves, their stakeholders and the world as a whole.

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Republished from the RFI Foundation’s weekly newsletter. Subscribe for free here!

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Blake Goud

Blake Goud

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Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.