Better data and disclosure crucial for pricing climate risks

Recent efforts don’t go far enough

Pandemic risks are not new, but the worldwide scale of the Covid-19 crisis underscores the importance of preparedness and adequate risk management to tackle ‘tail’ events. The virus outbreak is an important reminder of the risks that seem certain to arise from a threat even more ominous: climate change.

If climate risks are not addressed, catastrophic scenarios could materialise, with devastating effects on society, the economy, and the financial system.

The International Monetary Fund’s global financial stability report, published in April, looked at physical risks and their potential impact on financial stability through equity markets. Our analysis shows that global warming scenarios, and the associated projected changes in physical risks, are not reflected in aggregate equity valuations. Investors’ apparent lack of attention could become a significant source of market risk.

Stress-testing and scenario analysis will be important tools of climate-change risk management. Over the past decade, one-fifth of the examinations conducted by the IMF under the Financial Sector Assessment Program has included an examination of climate-related physical risks, with an increasing focus on transition risks. Given the cross-border spill-overs of climate change, taking a global dimension into consideration will be increasingly crucial. Regulatory and supervisory frameworks need to be strengthened, ensuring that supervisors review key exposures of financial institutions to climate risks and measure how they are being managed.

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