Canada’s financial sector could be exposed to significant economic shocks from the transition to lower emissions, but faster climate action can smooth out those impacts, according to early scenario modelling from the Bank of Canada and the banking regulator.
The pilot study isn’t meant as a forecast, but considers several climate policy scenarios and how they could play out across the Canadian economy, The Canadian Press reports. The scenario work, however, does emphasize the immense transitions underway, said Toni Gravelle, deputy governor of the Bank of Canada.
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“All scenarios showed that as we globally transition to net-zero, some sectors will be significantly impacted, and the economy as a whole will undergo significant structural changes.”
Speaking at a media briefing, Gravelle said the study shows that Canada’s banking and insurance industries need to plan carefully for the transition under way.
“For the financial sector, mispricing these climate risks could expose financial institutions and investors to sudden and large losses.”
The Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI) say the initiative is an early attempt to better understand the long-term risks posed by the transition away from greenhouse gas emissions, and to assess how well banks and other financial institutions are themselves modelling the risk.
Gravelle said both financial institutions and financial authorities are still in the early stages of building capacity to better understand the risks and transitions ahead.
Ben Gully, assistant superintendent at OSFI, said while many institutions are just starting to ramp up efforts, there’s still time as the regulator aims to establish resiliency by the end of the decade.
“We have some time, but no time to waste in preparing for 2030.”
The report says Canada is at higher risk of economic impacts from the transition because of significant exposure to commodities, particularly fossil fuels, that will see price declines as climate policies such as carbon pricing strengthen globally.
The scenarios show that faster action on climate change will lead to a smoother, less risky transition, CP writers. Modelling for especially abrupt global policy changes showed potential financial market disorder, with Canada’s GDP falling 10% from where it would be by 2050 compared with the baseline scenario.
The pilot study found that fossil fuel industries are particularly exposed to risk. Others, including crop and livestock sectors, would also take a hit, and the electricity sector would get a boost.
One scenario, which looked at moving immediately toward the policies needed to keep warming to 2°C, found that refined oil producers would see a 72% drop in net income and a 450% increase in the possibility of default by 2050, compared with a business as usual baseline. The crop farm could see a 32% drop and a 141% increase in default risk.
The 30-year scenarios made a series of assumptions, and didn’t factor in key factors like the physical risks of climate change, or how new technological innovations could change the trajectories, CP says.
The report, produced in collaboration six financial institutions, found that modelling can take more effort than expected, and is still hampered by spotty access to data.
Gully said the pilot was a success as an early effort, helping to raise awareness of the risks and working toward better understanding the implications of the shift off carbon.
“Climate scenario exercises like this one make clear the potential impacts of transition risk across a range of different climate pathways.”
This report by The Canadian Press was first published January 14, 2022.
