Brief: Climate as Systemic Risk

• Systemic financial risks are risks that threaten the financial system and economy as a whole, not simply a single asset, firm, or sector.
• Climate change presents a growing significant systemic financial risk. Systemic risks — including climate change — demand a macroprudential response.
• Global regulators' approach to climate risk will determine whether there is an orderly or disorderly transition away from fossil fuels and toward more resilient infrastructure and systems.
• Our current financial regulatory approach is not fit for purpose today, but with a corrective eye to current market blind spots, climate regulatory approaches can help mitigate expected economic upheaval.

Climate change poses a growing threat not only to individual companies and financial institutions, but to the stability of the financial system and the broader economy as a whole. Yet many of the traditional ways markets identify and manage financial risk are poorly suited to climate change, causing risks to be underestimated, overlooked, or recognized only after they predictably become more severe. Because financial markets are deeply interconnected, these risks can spread from one sector to another and the market’s failures to account for them ultimately affect households, businesses, and communities. Preventing this kind of disorderly outcome requires regulators to anticipate climate-related risks and act before they grow into wider financial and economic crises. 

This paper outlines the mandate to respond to known systemic financial risks, offers evidence of climate as a significant systemic risk, and foreshadows the difference between a disorderly versus orderly transition. It offers a review of core market barriers to an orderly transition and makes recommendations for addressing these barriers. It concludes with a case study of the insurance sector, which is exemplifying significant climate-distress today.