The European Union is set to discuss proposals for banks and possibly other financial firms to be stress tested for their exposure to climate change related risks, such as extreme weather or floods, according to documents seen be Reuters.
Reuters reports that European Union finance ministers and central bankers are set to will discuss the potential for “carbon stress testing” for the financial sector at their next meeting, to be held in Amsterdam on April 22nd to 23rd.
The stress tests would look at bank and financial firms ability to withstand scenarios based on climate change related risk, such as floods or severe weather, as well as their exposure to energy intensive sectors where assets can face the threat of repricing due to climate.
“The financial sector is also exposed to risks related to climate change itself,” Reuters reports the documents as stating, with extreme weather and flooding cited, and stress testing being “an important tool to assess these risks.”
This appears to be an extension of the climate risk disclosure work being undertaken by the Financial Stability Board’s Task Force on Climate-Related Disclosure, which has been working to get corporations to disclose their exposure to climate related risks.
However, the EU appears to be pushing this forwards and the hope will be that exposures that were once uninsured in the financial sector, so posing a risk to economies, will be highlighted and therefore can be addressed.
The question this raises, however, is whether EU banks should also be pushed to disclose exposure to catastrophic risks, such as earthquake risk for Italian banks. Similarly to in California, banks in Italy bear earthquake risk through mortgages, with property insurance not always sufficient or even in place to transfer the risk away from the provider of a home loan.
These uninsured catastrophe, weather and climate risks need to be backed by capacity, from insurance, reinsurance and capital markets, in order to remove the risk from governments and ultimately tax payers.
Stress testing and disclosure is a good way to achieve this, as well as to identify organisations which can become more climate neutral and are bearing risks unnecessarily.
The goal should be the transfer of climate, weather and also (we feel) catastrophe risks, above certain levels of retention, to insurance, reinsurance and ILS or capital markets.
For the re/insurance and ILS market there could be significant opportunity to provide the risk capital required to enable the transfer of these risks away from corporations, the financial services sector, government and ultimately taxpayers, thus providing the tools for recovery when climate events occur, severe weather strikes, or a catastrophe occurs.
Allowing large corporates to continue to bear these risks, which essentially means the risk ultimately sits with shareholders, governments and the population, is increasingly being viewed as unacceptable. This protection gap deserves to be covered and the EU’s push for stress testing on climate exposures should be welcomes, as one way to ensure responsibility is placed with those who need to protect their businesses and society as a whole.
Read our series of articles focused on the insurance protection gap – under-insurance in emerging and developing economies, the gap between economic and insurance losses, and transferring risk from public sector to private – the opportunity that is on every reinsurance CEO’s lips and which presents the largest opportunity to put excess risk transfer capital to use, requiring both traditional and capital markets support.