The Bank of Canada began disclosing climate-related risks to its operations and balance sheet this week – a move intended to inspire other financial institutions to raise their game on climate-related disclosure.
The report, published alongside the bank’s annual report on Monday, details the bank’s own greenhouse gas emissions and looks at how vulnerable its operations are to natural disasters. It also attempts to quantify how exposed its balance sheet and pension plan are to climate-related risks.
The central bank is not a normal financial institution, and the risks it faces are considerably different than those experienced by commercial lenders. Still, the report offers a basic model for disclosure at a time when regulators are leaning on financial institutions to explain their vulnerability to climate change – both physical threats, such as fires and floods, and risks tied to changing regulations and consumer demand.
“By disclosing this, and by signalling to the market that the central bank thinks this is important enough to release a report on, it also signals to the financial institutions and to the system that this is something they’re going to have to do,” said Ryan Riordan, a professor of finance at Queen’s University and director of the university’s Institute for Sustainable Finance.
Last month the Office of the Superintendent of Financial Institutions, Canada’s banking regulator, published guidelines that will require banks and large insurance companies to beef up their climate-risk disclosures and put plans in place for the transition to a low-carbon economy. The regulator stopped short of prescribing specific increases in capital buffers to deal with climate risks, but did suggest tying executive compensation to climate risk management.
The Bank of Canada’s report spells out potential challenges to its operations and to its goal of keeping inflation low and stable. It says, for example, that increased natural disasters could lead to severe supply shocks, while changes in oil demand could affect Canada’s exchange rate.
“Changes in weather patterns could lead to greater volatility in headline inflation (e.g., food prices), which in turn could impact inflation expectations,” the report said.
“The uncertain effects of global warming on the economy and the transition path to decarbonization also pose significant challenges to the bank’s ability to forecast potential output and long-term economic growth,” it added.
The bank’s attempt to analyze climate-related risk on its balance sheet comes with significant caveats. Climate finance is a new field and there are “considerable limitations in data, metrics and measurement techniques,” the report says.
The discussion of risk also involves a certain amount of abstraction. Almost all the central bank’s assets are Government of Canada bonds – a very different situation than for commercial banks, which hold a wide mix of securities and loans to businesses and households.
Nonetheless, the report tries to quantify the riskiness of these government bonds using the metric weighted average carbon intensity, or WACI. The result is not flattering for Canada.
The WACI of federal government bonds is “significantly higher than the G7 average mostly driven by the relatively large size of Canada’s carbon-intensive oil and gas industry,” the report says.
The Bank of Canada doesn’t buy government bonds as an investment, and it isn’t about to unload them because of their relatively high carbon intensity. But the report does say hopefully that “the WACI of those bonds is expected to decrease as Canada decarbonizes and works toward the government’s goal of net-zero emissions by 2050.”
The report also points to areas where the central bank is making progress on environmental issues. The Bank of Canada’s move to polymer bank notes reduced the amount of waste it was producing, while building renovations have significantly reduced its energy and water usage.