The Central Bank of Brazil and Climate Change
“Central banks should regulate and supervise the financial system in relation to risks related to climate change, as the financial system underestimates financial risks and fails to adequately address the issue. In this way, central banks should help the private financial system assess climate risks more realistically.”
Douglas Alencar, Federal University of Pará
Wallace Pereira, Federal University of Pará
Are the policies adopted by the Central Bank of Brazil (BCB) sufficient to protect the national financial system from the risks associated with climate change?
We don’t believe so.
In fact, the BCB is lagging terribly in terms of regulations and supervision regarding climate change. So far, in fact, the BCB has only held limited public consultations regarding the impact of climate change on the financial system; and the new rules require commercial banks to report merely on their governance in relation to environmental risks.
Could this be a case of too little too late?
Climate change and environmental problems are on the agenda of global discussions and financial systems, as discussed by the world’s main central banks. The situation is dire: we are experiencing severe problems related to water scarcity and plastic pollution in the oceans. It is estimated that by 2050, there will be more plastic than fish in the oceans, and deforestation, especially in the Brazilian Amazon, will lead to a loss of biodiversity.
Climate change can impact the stability of national financial systems in numerous ways. The first risk related to climate change arises from the transition from the current economy to a low-carbon economy. This will generate a reassessment of portfolios and investments along with changes in the scope of the national financial system, thereby causing economic shocks.
The second risk related to climate change is physical risk, which is linked to the economic damage caused by climate change-related events.
In response to these issues, the BCB will require commercial banks to report environmental risks, and how to tackle them with respect to the two above-mentioned aspects. This, however, is grossly insufficient when we consider the possibilities of the BCB in terms of total risk reduction, if the BCB chooses to encourage the transition to a low-carbon economy. Reducing systemic risks could contribute to the development of technologies that can leverage Brazilian economic development in the coming decades.
Moreover, we may ask how a rise in the planet’s temperature and various other catastrophes caused by climate change affect corporate profits and financial systems? These losses can affect bank portfolios and create fragility in financial systems. If firms experience a drop in profits caused by environmental problems, how might this affect liquidity preferences? It could drive asset sales, which, in turn, can trigger financial crises. Faced with these challenges in the future, policies could contribute to reducing the potential of the destabilizing components of climate change.
Considering climate issues, the BCB published BCB Resolution №139 on September 15, 2021, which deals with environmental risk. In this resolution, the BCB discusses the disclosure of the Social, Environmental, and Climate Risks and Opportunities Report (GRSAC Report). Financial institutions must periodically release these reports.
Through the GRSAC Report, financial institutions must disclose information on topics associated with social, environmental, and climate risks. In particular, the BCB is interested in information related to: i) governance of risk management, including the attributions and responsibilities of the institution’s administrative and managerial bodies that are involved in the management of above-mentioned risks; and ii) relevant actual and potential impacts of environmental risks involved in business strategies, and risk and capital management in the short-, medium-, and long-term horizons, considering different scenarios, according to documented criteria.
However, the BCB exempts financial institutions from reporting information regarding opportunities related to the transition to a low-carbon economy, as well as issues related to climate factors. This implies that the most important issues related to the risk to businesses from climate catastrophes, and those related to the transition to a low-carbon economy, are excluded from the report.
A comparison with other central banks such as the Bank of England (BoE) reveals that the BoE included the incentive to transition to zero carbon emissions in its mandate. The European Central Bank (ECB) announced that it would take action to incorporate climate change into bond collateral. Thus, while the central banks of Europe and England are incorporating climate change into their operations, the BCB, at most, asks the financial system how it views climate change.
The discussion regarding the supervision and regulation of the financial system, at the international level, includes whether central banks should, i). focus their attention on the exposure of the financial system to climate change, ii) pay attention to the systemic risks related to climate change, or, iii) play a more active role in promoting rules that can induce a transition to a low-carbon economy.
When the central bank creates a rule or imposes a new report on the financial system, it is actually shaping the financial system’s response to climate change. Therefore, BCs are not neutral in relation to climate change. These institutions are central to the contemporary capitalist system, and their attitudes and actions exert a real impact on the economy.
It can be argued that the ECB’s policies are closer to risk exposure, given that it concentrates actions related to climate change on financial institutions in the Euro zone, while the actions of the BoE to encourage the transition to a low-carbon economy are more related to a systemic risk approach.
Central banks should regulate and supervise the financial system in relation to risks related to climate change, as the financial system underestimates financial risks and fails to adequately address the issue. In this way, central banks should help the private financial system assess climate risks more realistically. Additionally, climate risks should be reflected in the transition to a low-carbon economy beyond mere regulation and supervision.
Among the policies that the central bank should adopt is the policy of higher capital requirements for assets that exhibit greater climate risk. Additionally, when lending resources to the private sector, the interest rate should be higher for sectors with the greatest impact in terms of carbon emissions, offsetting lower interest rates for low-carbon sectors and businesses.
Climate risk poses a challenge to the entire financial system. Therefore, the BCB should implement policies to accelerate the transition to a low-carbon economy in Brazil. By doing so, it would not only contribute to the reduction of systemic risk but also provide an opportunity for economic development. The transition will provide opportunities for economic growth with innovation, new sectors, and greater productivity. The BCB could be a pioneer in this process, where it is currently lagging, as demonstrated.