October 2019

Posted by Anton Murray Consulting on . Posted in 2019

On 4 October the Reserve Bank of Australia released their biannual Financial Stability Review, a report which evaluates the state of the domestic and global economy, considering various risks and providing a detailed analysis of various topics. One of the key areas of focus for the October Review was climate change and the risks to financial stability that it carries. The RBA highlighted three key risk types: physical, transitional and liability risks.

Physical risks will be felt the most by insurers and lenders. Insurers have already seen a marked increase in insurance claims for natural disasters with inflation-adjusted claims more than doubling compared to the last decade. Crop, health and life insurance policies will be required to adjust to new risks, many of which are difficult to quantify. Lenders are exposed to physical risk when the collateral they lend against is compromised by climate change. If assets or household wealth that are reliant on agricultural or tourism-related income start to falter, these loans may become unserviceable.

Transitional risks are broader in their impact. Carbon-intensive industries such as mining and power generation, and the financial instructions exposed to them, face transition risk. Beyond institutions, retail customers with investments in firms that are energy-intensive in their production processes and operations assume aspects of the risks faced by those companies, should market sentiment shift suddenly. There are further unpredictable risks posed by regulatory changes. Market shifts could also be governed by consumer preference, with more and more individuals, as well as investors, favouring environmentally-friendly firms.

Liability risk refers to financial institutions’ potential reputational damage if their response to climate change is deemed inadequate. Firms may also experience damage to their reputations if they are seen to be contributing to climate change or failing to manage risk to the climate.

There are obviously a number of issues with managing and offsetting these risks. Data and research on the area is limited, making it more difficult for firms to protect themselves. It’s also not an easy task to measure the effect of climate change on asset prices. The impact of climate change on the Australian and global economy will be felt broadly. APRA and ASIC are working to manage the risks, but each individual and firm also holds a responsibility to mitigate the potential damage.

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