Towards a framework for supervising and measuring climate-related financial stability risks in Colombia

Towards a framework for supervising and measuring climate-related financial stability risks in Colombia

Daniel Osorio, Head of Financial Stability at the Banco de la República (Central Bank of Colombia)

The reality of climate change is already presenting new challenges to policymakers around the world. The gradual, cumulative effect of structurally different weather patterns, such as more extreme temperatures or changes in rainfall intensity, is already having (in some cases devastating) consequences on the performance of local economies and financial markets.

In terms of financial stability, there seems to be a wide consensus with regard to the most important sources of risks created by climate change[1]. One may argue that these risks underlie any structural change in economic performance, not only those caused by climate change. Indeed, transition risks are tightly linked to the role of the financial system as a vehicle for the reallocation of real resources; physical and liability risks relate to the role of the financial system as a tool for shock absorption. However, financial stability policy is especially affected (in the near future, perhaps determined) by climate change given the potentially gargantuan size of its cumulative effects.

Colombian financial authorities have acted to build the analytical foundations for the management of these risks, with the understanding that the exposure of the economy to climate shocks may be sufficiently high to warrant its own policy framework. The Financial Superintendence (in charge of supervision and wide swathes of regulation) has taken major steps as part of a multi-year strategy in: (i) establishing a common taxonomy of activities and instruments in close alignment with international standards; (ii) defining guidelines for the issuance and disclosure of green bonds with the aim of promoting transparency and market integrity; and (iii) using emerging tools to measure (and eventually divulge) climate-related financial risks.

The Central Bank has reinforced its research activity on the macroeconomic effects of climate change and the design of a climate stress test exercise, in order to assess the resilience of the domestic financial system to shocks arising from physical risks. The latter has become more important in light of recent evidence on the effects of more extreme “El Niño” and “La Niña” weather patterns on loan quality in Guatemala, with Colombia being worryingly exposed to the weather phenomenae. The Superintendence and the Bank recently joined the Network for Greening the Financial System (NGFS) in search of best practices to tackle the questions of how to manage climate risks in financial markets and how to incentivize a switch to a more sustainable financial system.

Looking ahead, it is clear that some features of the economy will irreversibly change as a consequence of the global pandemic. Policy action will help determine the speed and shape of this transition. In this context, policymakers across the world have a “window of opportunity” to engineer a ‘greener’ transition in which climate risks are adequately measured, supervised, managed, and ultimately, controlled.

[1] See Carney (2018) for a brief explanation of transition, physical and liability risks in this context.