Green Finance

Risk and Opportunity

The transition to a low-carbon economy will require enormous financial resources. Source: Bloomberg

The Trump administration’s decision to back out of the Paris Agreement is a huge setback in the battle against climate-related risks. But reactions to this move show that governments the world over are determined to stand firm on the climate accord’s ambitious goals. Notwithstanding the short-term mood, we don’t expect a change of direction: The transition to a low-carbon economy is already underway.

The role of banks and other financial institutions in this transition is greatly underestimated. The financial sector isn’t immune to the processes of adaptation. For example, the transition to a low-carbon economy could make a whole range of asset re-evaluations necessary once real costs become apparent.

Companies, investors, and lenders active in impacted industries will have to expect declines in returns. We have already seen a number of drastic devaluations. As Mark Carney, chair of the G20’s Financial Stability Board, has noted, the market capitalization of the four most important US coal producers plummeted by a good 90 percent over the past six years.

Dealing with these risks ought to be at the top of the financial sector’s agenda. But many banks and institutions still aren’t in a position to identify or quantify the loan and market risks to their accounts receivable from a climate protection perspective.

There are a number of reasons why this is a challenge. Firstly, it concerns a long-term development whose outcome remains uncertain. Secondly, historical data is of little use in projections. And thirdly, the whole process is politically influenced to a high degree, adding still greater uncertainty.

Lawmakers and supervisors must do their homework, too. The G20 put Green Finance on the agenda in 2015. This year’s German G20 presidency has set the goal of achieving further progress in two key areas. Just recently, a working group convened by the Financial Stability Board and led by industry representatives presented recommendations on voluntary and consistent disclosure by companies of climate-related financial risks.

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