By Mirko Mallia - Deputy Head, Financial Stability, MFSA
In recent years, there has been a global consensus on the urgent need to address climate change to safeguard our planet's future and ensure the well-being of current and future generations. While discussions often focus on environmental impacts, it is increasingly clear that climate change poses significant risks to financial stability.
The Link Between Climate Change and Financial Stability
Climate change introduces multifaceted risks to financial stability, impacting both the short-term and long-term viability of businesses, assets, and economies. Immediate risks stem from physical damage caused by extreme weather events such as hurricanes, floods, droughts, and heatwaves. These events can disrupt supply chains, damage infrastructure, and lead to significant financial losses for businesses, which in turn affect the financial sector, including banks and insurers.
Moreover, the transition to a low-carbon economy presents transition risks for industries reliant on fossil fuels. As governments worldwide implement policies to mitigate climate change, such as carbon pricing and renewable energy incentives, companies in high-emission sectors may face stranded assets, reduced profitability, and regulatory penalties. This transition risk can impact asset valuations, loan portfolios, and investment returns, thereby affecting the stability of financial institutions.
Strengthening Climate Risk Analysis
Recognising the significance of these risks, the MFSA’s Financial Stability team has intensified its analysis and contributions to discussions on climate-related risks, both within the organisation, as well as with external stakeholders such as the European Central Bank, the European Systemic Risk Board, and International Monetary Fund. Since February 2020, the Authority has also been a full member of the Network for Greening the Financial System (NGFS).
About the NGFS Membership and Role
The NGFS is a coalition of central banks and financial regulators worldwide dedicated to addressing climate change by promoting sustainability in the financial services sector. Within the NGFS, experts collaborate to understand the impacts of climate change on the financial system. This involves advanced analyses of climate-related risks for banks, insurance companies, and other financial institutions. The network seeks effective strategies to manage these risks, playing a pivotal role in initiatives that enhance the financial sector's resilience to climate change and support the transition to a sustainable future.
Financial Stability Analysis on Climate Change
The MFSA's Financial Stability team focuses on assessing transition risks, drawing insights from international research, such as studies by Battiston et al. The team continuously monitors the exposure of Maltese financial entities to sectors most susceptible to climate-related risks, providing valuable insights into the interaction between financial systems and climate policy, particularly in sectors heavily impacted by climate change.
An in-depth examination of Malta's financial landscape has been conducted, exploring the effects of various levels of carbon taxation on investment portfolios. This study evaluates the immediate impact of such taxation on licence holders' investment portfolios, highlighting the complex relationship between climate policy and financial stability, and offering valuable insights from a policy perspective.
Ongoing Commitment to Climate Change Assessments
The MFSA will continue integrating climate change assessments into macroprudential analysis, aligning with the collection of additional data in this field and the development of more advanced quantitative models. This ongoing commitment ensures that the financial sector remains resilient in the face of climate change, safeguarding the stability of the financial system and supporting a sustainable future.
