Reserve Bank warns against risk to financial stability

Australia's central bank has delivered a clear warning that climate change is exposing financial institutions and the financial system more broadly to risks that will rise over time if action isn't taken.

The RBA's financial stability review, released Friday, concluded that while climate change is not yet a significant threat to financial stability in Australia, it is becoming increasingly important for investors and institutions to actively manage carbon risk.

The bank notes Australian insurers are the most directly exposed to the physical impacts of climate change, and points out that inflation-adjusted insurance claims for natural disasters this decade are more than twice what they were in the previous 10 years. It notes "this impact is likely to grow over time". "An increase in the frequency and severity of natural disasters will increase the incidence of damage to, or destruction of, physical assets that are insured or used as collateral," the RBA said.

"Assets that are exposed to increasing physical risk - such as property located in bushfireprone or coastal areas - could decline in value, particularly if these risks become uninsurable.

"Climate change could also reduce certain types of business income that is used to service loans. Examples include changing rainfall patterns that result in lower or less predictable income from agriculture, more frequent storms disrupting supply chains and therefore sales, and damage to natural assets that reduces tourism income."

The RBA says banks and other lending institutions are also exposed to physical risks because climate change can result in a decline in the income or value of collateral that they are lending against.

It says Australian financial institutions that have exposure to carbon-intensive industries - such as power generation and mining, or to energy-intensive firms - "will also be exposed to transition risk".

"Transition risk will be greatest for banks that lend to firms in carbon-intensive industries and to individuals or businesses that are reliant on these firms," the bank said.

"Other financial institutions investing in carbon-intensive industries, such as superannuation and investment funds, are also exposed to the risk that climate change will diminish the value of their investments. This could occur both through direct investments in carbon-intensive industries, or indirect investments in banks these industries".

It warns financial institutions "also face reputational damage if they are seen to be contributing to climate change or failing to manage climate risks".

The RBA concludes that climate change poses a clear systemic risk, but it is not yet an imminent threat to financial stability. But it warns this could change. "Climate change could emerge as a risk to financial stability if it is not properly managed, or if the size of climate-related losses increased materially.

"Rising climate-related losses could also erode confidence in an institution or the financial system, leading to a withdrawal of funding. This would be more likely if the physical impacts of climate change are more severe or occur sooner than currently projected, or if the transition to a low-carbon economy occurs in a disruptive and costly manner."

The RBA notes that both the banking regulator Apra and the corporate watchdog Asic have become proactive in managing carbon risk, and the Council of Financial Regulators has established a working group on the financial implications of climate change to help coordinate agencies' actions.

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