Breaking the climate-finance doom loop

In the absence of strong regulation, the financial sector continues to fuel the climate crisis by lending to and insuring harmful fossil fuel projects which not only threaten our planet, but expose the economy and financial sector itself to growing risks resulting from environmental breakdown.

The Climate and Capital conference this week, organised by the Bank of England and, the Prudential Regulation Authority (PRA) to look at the role of financial regulation in addressing those risks is therefore a key moment.

To push for decisive action by our financial regulators, we have written an open letter to Governor Andrew Bailey and PRA CEO Sam Woods endorsed by leading thinkers and academics, calling for them to break the finance-climate ​‘doom loop’ in which financial activities continue to fuel climate crisis and in turn increase risks to the financial system itself.

The climate crisis poses a grave and growing threat to the financial system and macroeconomic stability in two ways:

• physical risks, resulting from the increasing frequency and severity of severe weather events and environmental damage that will hit the economy and lead to financial losses
• transition risks, as the UK and other economies transition towards net-zero emissions, fossil fuel assets will increasingly decline in value (to zero) and eventually become ​‘stranded’

The Bank has an important role to support the government in mitigating those risks. When banks or insurance companies make loans, they have to keep a certain amount of funds on their balance sheet to cover any potential losses. These are called ​‘capital requirements’ and the Bank of England should adjust these to make climate-risky activities more expensive to fund.

We call on the Bank to adopt a strong precautionary approach, taking the necessary measures in advance before the worst impacts of climate breakdown materialise by:

• Introducing higher risk weights on any assets linked with new fossil fuel production in line with a ​‘one for one’ rule, where each pound of financing for such activities must be matched with one pound of a lender’s own funds.
• Adjusting risk weights on existing fossil fuel assets over a gradual phase-in period to appropriately reflect their higher risk of losing value

By increasing capital requirements on financial activities that contribute towards climate breakdown, notably lending to and insuring new fossil fuel projects, responsible and forward-looking regulation can break the finance-climate ​‘doom loop’ in which financial activities continue to fuel the climate crisis and in turn increase risks to the financial system itself.

The basic (minimum) capital requirements are set by the internationally agreed Basel framework. The Bank of England, long one of the thought leaders in considering climate-related risks, should now lead by adjusting its capital framework accordingly and use the important voice it has in the international standard-setting bodies such as the Basel Committee to push for an international set of rules that address climate-related financial stability risks at a global level.

Read the open letter.

Image: iStock/​Dark_​Eni