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The financial world is making the same mistakes regarding climate change as it did with the housing market in the lead-up to the 2008 global financial crisis, a new report warns.
Degrees of Risk – co-authored by Ian Dunlop, a former head of the Australian Coal Association – found that while regulators and the financial sector had begun to grapple with the risks posed by the climate crisis, they were not moving fast enough.
Instead, they were relying on modelling scenarios of 3C and 4C of global heating without properly factoring in how catastrophic they would be.
Dunlop said the sector needed to be acting to keep warming as close to 1.5C as possible, in line with scientific warnings, and then draw atmospheric carbon dioxide down to safe levels if it was “to survive and prosper into the future”.
The report, published by a group called the National Centre for Climate Restoration (Breakthrough), said the financial sector’s approach to the climate crisis was similar to the GFC – when catastrophic housing debt led to a crash. In both cases, it relied on overly optimistic financial models that led it to assume it could avoid disaster.
On climate, it pointed toguidelines published by the Australian Prudential Regulatory Authority (Apra) in April encouraging banks and financial institutions to conduct “stress tests” on their organisations under scenarios where the world reached 3C or 4C heating.
It compared this to a heavy reliance in the mortgage crisis in 2008 on modelling to judge whether bundles of bad debts being traded were safe.
Dunlop said in the wake of the Intergovernmental Panel on Climate Change (IPCC) report published last week, a focus on collecting more data over action could be dangerous. He said scenario analysis or stress testing was helpful in some cases, but many institutions were concluding they may survive a worst-case scenario.
“You’ve got to have the business world facing up to the fact that its survival now depends on serious action to get emissions down,” Dunlop said.
The report painted a stark picture of what is expected under the worst-case scenarios. “As a general rule of thumb, global average warming of 4C (covering land and ocean) is consistent with 6C over land, and 8C in the average warming over mid-latitude land. That risks 10C in the summer average, or perhaps 12C in heatwaves,” the report said.
It noted western Sydney had already reached 48C in summer. “If you add 12C to the 48C you get summer heatwaves of 60C,” the report said. “Bank customers would be dead on the streets.”
These are the most extreme scenarios imagined where societies and economies break down under pressure from profound changes in climate.
Speaking to the Joint Standing Committee on Trade and Investment Growth last Friday, the Apra chair, Wayne Byres, described the guidelines as a means of encouraging institutions to look deeper.
“Importantly, the guidance neither promotes nor prohibits specific investment, lending or underwriting decisions: it simply seeks to support well-informed decision-making,” he said. “It is also designed to be flexible, allowing each institution to adopt an approach that is appropriate for its size, customer base and business strategy.”
Dunlop said it would be better to take a “precautionary approach” that accepted a scenario of 3C or 4C was untenable and that business should “throw everything” into averting the outcome by seeking to divert finance away from carbon-intensive projects.
“[Otherwise] it becomes paralysis by analysis,” Dunlop said. “Our point, quite simply, is you don’t use scenarios in these extreme situations where the costs are infinite and the economy is going to collapse. The implication is that you’re not going to have an economy.”
Dr Karl Mallon, the chief executive of Climate Risk Engines, which advises government, business and private clients on climate risks, “welcomed” discussion of the issue but said there was still value in studying worst-case scenarios.
“In terms of a practical way forward, it’s not useful to say that under a 4C world civilisation as we know it is over, so there are no risks to test,” Mallon said. “In my view it’s still a useful exercise because it starts to say ‘these are not immaterial costs’. And then we start to put a value on adaption and solving the problem.”
Dan Gocher, from the Australasian Centre for Corporate Responsibility (ACCR), said that many companies were spending too much of their time on forecasting and not enough on actually making a change.
“The problem we’ve seen at ACCR with companies and investors doing scenario analysis is that they come away with all these assessments saying these assets are good, those assets are bad, and these are questionable at 4C, but it doesn’t change their thinking about today,” Gocher said.
“When it comes to supply chains, for example, you can’t just cut and copy one supplier for another under 4C warming. It’s good that someone is saying that 3C of warming doesn’t just mean 3C warmer temperatures.”
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