The Regulatory Response to Climate Risks: Some Challenges

Driven by human behaviour, climate change is unequivocal and unprecedented. According to the sixth Intergovernmental Panel on Climate Change (IPCC) report, the average global surface temperature has risen by around 1oC since the late 19th century and the pace of increase since 1970 is faster than in any other 50-year period over at least the past 2,000 years. Even in the best-case scenario of immediate, rapid and significant cuts in greenhouse gas (GHG) emissions, the average surface temperature will increase 1.5oC in the next 20 years over pre industrial levels. Under a very high emissions scenario, average warming could reach almost 2oC by 2040 and over 4oC by 2100. Translating this into financial terms, a 1.5oC temperature increase would shave 8% off global GDP by 2100. Thus, there is a clear case for a determined and comprehensive policy response to foster a swift and orderly transition towards a low-carbon economy. Through a combination of policy instruments, such as carbon taxes, subsidies, guarantees and public infrastructure, governments can create a framework of incentives (and disincentives) that could foster innovation and steer consumers and corporates towards their sustainability goals. If sufficiently ambitious, such policies could ensure that emissions reductions targets are met while at the same time mitigating unnecessary disruptions to the economy.

This paper by the BIS reviews, from a technical point of view, the challenges that authorities would face in seeking to adjust the prudential framework to cope with climate-related financial risks, and discusses different policy options.