Climate Change Hurts Also Banks and Public Debt

A NEW STUDY BY VALENTINA BOSETTI AND CO AUTHORS, PUBLISHED IN NATURE CLIMATE CHANGE, FINDS THAT 20% OF THE ECONOMIC DAMAGE OF CLIMATE CHANGE IS DUE TO THE DISRUPTION OF THE FINANCIAL SYSTEM. BANKING CRISES WILL BE MORE FREQUENT, WHILE RESCUING INSOLVENT BANKS WILL CAUSE AN ADDITIONAL FISCAL BURDEN

A new study by Valentina Bosetti (Department of Economics and Senior Scientist at RFF-CMCC European Institute on Economics and the Environment) and three co-authors from CMCC, Scuola Superiore Sant’Anna and Politecnico di Milano, published in Nature Climate Change, highlights that might affect even an apparently less exposed sector such as finance. More in detail, the climate-induced instability of the financial system might significantly increase, thus amplifying the impacts of climate change on economic growth.  The study is the first to examine this effect: the outcomes of the analysis suggest that climate change will increase the frequency of banking crises (from +26% up to 148%) while rescuing insolvent banks will cause an additional fiscal burden of approximately 5% to 15% of GDP per year and an increase of public debt to GDP by a factor of 2 in the year 2100.
 
«We discussed», says Professor Bosetti, «about the direct damages that climate change exerts on economic growth while trying to establish the contribution of climate-induced financial distress to such a shrinkage of economic performances. We found out that around 20% of growth rates reduction observed is attributable to financial distress».
 
According to the study’s lead-author, Francesco Lamperti, Assistant Professor at Scuola Superiore Sant’Anna in Pisa and Junior Scientist at the RFF-CMCC European Institute on Economics and the Environment, «the idea behind our research was to understand how the impacts of climate change will affect the global banking system. Actually, the impacts concern firms because climate change affects and reduces the productivity of labor and the stock and quality of capital. However, cascades of firms’ bankruptcies induced by climate damages might affect the financial system. In particular, we sought to understand how the global banking system could be challenged by firms’ insolvency, quantifying banking crises and the public costs of bailing out insolvent banks. On the one hand, we wanted to investigate the stability of the financial system, on the other, we wanted to assess the contribution of climate-induced financial distress to such a shrinkage of economic performances due to the deterioration of the banks’ balance sheets induced by climate change. We know in fact that crises in the banking system exacerbate the downturns in the real sector through credit crunches, that is, periods of substantially reduced credit inflow blocking the investments of firms. This in turn may further reduce the economic growth».
 
«The main result», explains Massimo Tavoni, Director of RFF-CMCC European Institute on Economics and the Environment and professor at Politecnico di Milano, «is that climate damages significantly reverberate to the financial system: our results clearly show that firms’ survival likelihood reduces almost three times, while the risk of banking crises doubles. This entails further costs, that is an additional fiscal burden of approximately 5% to 15% of GDP per year to absorb losses and rescue insolvent banks».
 
Another interesting result of this study focused on the possible measures that financial regulation authorities can implement to manage and reduce climate-related risks. Researchers tested in particular whether macro-prudential policies can help mitigate the costs of banks’ bailouts. “The study highlights”, says Andrea Roventini, Professor at Scuola Superiore Sant’Anna in Pisa, “that financial regulation authorities can modify banks’ capital requirements, accounting for the impacts of climate damages on firms’ solvency while reducing risks to the financial sector.”
 
Therefore, the authors note that leaving out the financial system from climate-economy integrated assessment may lead to an underestimation of climate impacts, and that financial regulation can play a role in mitigating them. Nonetheless, even if macro-prudential regulation is in place, the impact of climate change on financial crises remains dominant. This calls for the association of macro-prudential policies with broader and more effective adaptation and mitigation strategies while fostering investments towards low carbon projects.
 
Francesco Lamperti, Valentina Bosetti, Andrea Roventini, Massimo Tavoni, The public costs of climate-induced financial instability, in Nature Climate Change, DOI:10.1038/s41558-019-0607-5.

by Ezio Renda