Risks associated with climate change

Speech by the Governor of the Bank of Spain, Pablo Hernández de Cos, on “climate risk, energy transition, financial risks and global economic growth”.

Below you can find the main highlights from the Governor's speech:

• Risks associated with climate change. The financial sector is exposed to “physical risks” derived from increasingly extreme meteorological events, and also to transition risks due to “a broad transformation of technologies of production and a reallocation of activities between the different sectors and companies”, that will impact corporate profits, increasing inequalities and the probability of default on some of the loans granted.
   
• The materialization of the risks associated with climate change is a matter of concern for central banks, due to the difficulty in meeting their price stability objectives and their possible impact on interest rates and on credit institutions through a higher probability of default rates.
   
• Importance of climate stress tests. Measuring and modeling the impact of climate change on financial stability, quantifying the amount of the above risks, is one of the supervisor's current priorities. For that purpose, it is essential to have analytical results in order to assess the resilience of the financial system. However, the Governor points to two types of problems that he is currently facing:

1. Lack of metrics and limited information on the exposure of financial entities to these climate risks.
2. Lack of similar previous experience, which makes it difficult to model the risks derived from climate change.

• The ECB has recently published its climate stress tests for the economy, using different climate change scenarios (orderly, disorderly transition and level of global warming). “The results show that the long-term benefits derived from the early adoption of policies that drive the transition to a carbon-free economy, in general, more than outweigh the short-term costs of this transition”.
   
• Governments will have to allocate public resources in the fight against climate change, to “reduce the costs of the transition to a 'cleaner' economy and leave no one behind in the process”. In his opinion, efforts to fight against climate change should not depend on the fiscal position of each country, since it is a global issue that requires coordinated action. Regarding the European response through the Next Generation EU program (NGEU), the Governor comments that it will be necessary to extend the duration of the NGEU and  to increase its endowment “if we want to fulfill what is promised to future generations: a more sustainable economy from a financial, social and environmental point of view”.