Guest essay by Eric Worrall
What is the difference between a centrally planned Communist economy, and an economy where Central bankers punish businesses which defy their investment directives?
Global Warming Is a Central Bank Issue
13 April 2018, 3:30 PM
Last week, central bank governors from the U.K., France and the Netherlands met in Amsterdam to discuss how to adapt regulation to the risks posed by climate change. Together with five other institutions (from China, Germany, Mexico, Singapore and Sweden), these central banks have formed the “Network for Greening the Financial System” (NGFS). This group has two objectives: sharing and identifying best practices in the supervision of climate-related risks, and enhancing the role of the financial sector in mobilizing “green” financing.
To do so, central bankers may need to extend the supervisory horizon beyond their usual time span. Climate change may only pose a threat for the balance sheet some years down the road, but these risks should be assessed now. Villeroy de Galhau argued in his speech that the financial sector should move towards “a compulsory transparency requirement,” so that companies are forced to provide a snapshot of their climate-related risks. It’s an idea supervisors around the world should embrace.
The idea that central banks should promote “green investment” — which the central bank group also endorses — is more problematic. For a start, the goal could conflict with the main central bank objective of preserving financial stability. For example, if a bank loan to a company which produces renewable energy is given a lower risk weight than now just because it is “green,” then supervisors would be giving banks the wrong incentive to load up on such assets. To his credit, Villeroy de Galhau said he would be against giving “green” assets a lower risk weight when establishing capital requirements — though it’s an idea which the European Commission is currently looking at.
But the French central banker said he would be in favor of giving higher risk weights to “brown assets,” which contribute to polluting the environment. He added that these could be included in the so-called “Pillar 2” requirements — which are set independently by supervisors. This plan would make “brown” assets dearer to hold in relative terms, but would not change the risk weight which is attached to “green” assets. The idea is that “brown” assets would become riskier as the world moves towards a low-carbon economy.
The suggestion that insurers are vulnerable to climate risk is ridiculous, but don’t take my word for it – read Warren Buffett’s explanation.
… Over the years, inflation has caused a huge increase in the cost of repairing both the cars and the humans involved in accidents. But these increased costs have been promptly matched by increased premiums. So, paradoxically, the upward march in loss costs has made insurance companies far more valuable. If costs had remained unchanged, Berkshire would now own an auto insurer doing $600 million of business annually rather than one doing $23 billion.
Up to now, climate change has not produced more frequent nor more costly hurricanes nor other weather- related events covered by insurance. As a consequence, U.S. super-cat rates have fallen steadily in recent years, which is why we have backed away from that business. If super-cats become costlier and more frequent, the likely – though far from certain – effect on Berkshire’s insurance business would be to make it larger and more profitable.
As a citizen, you may understandably find climate change keeping you up nights. As a homeowner in a low-lying area, you may wish to consider moving. But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries. …
Climate change might make insurance more expensive, but climate change might also make weather insurance more necessary. Insurers recoup any losses by raising their premiums to match the risk.
Central bankers of all people should be aware of this simple insurance business reality. So how do we explain the apparent ignorance behind claims that insurance businesses will be badly affected by climate change?
One possible explanation might be that central bankers see climate change as a convenient excuse to seize greater control of the economies they are tasked with governing, though I guess it is also possible that bankers making the climate insurance claims are utter incompetents.