Covid-19 lessons for sustainable finance

Financial sector’s role in mitigating risks from parallel crises

We are in the midst of an unprecedented crisis. Apart from the tragic loss of life, the economic implications will be felt for years. This will not only be in terms of the businesses that have closed, many of which will never re-open, but also through effects on employment and career development, and the massive levels of debt that governments are incurring to support their economies.

For years, scientists have warned about the probability of a pandemic. Yet governments around the world cut health budgets, including those aimed at dealing with situations like Covid-19. In the UK, a cross-government pandemic influenza outbreak drill took place in October 2016. Exercise Cygnus, as it was called, concluded that the National Health Service would need thousands more intensive care beds, that doctors would have to start triaging patients and only help those with a better chance of survival, and that there would be a shortage of protective gear available to frontline staff. The required investments in equipment and facilities were never made and tragically those predictions have become a reality in the UK, which has the highest Covid-19 death rate across Europe. Similarly, over the last three years the US has cut the funding and workforce of the Centre for Disease Control, and now has the world’s highest death rate, with more than 85,000 at the time of writing.

A parallel can be drawn to scientists’ warnings of a climate catastrophe. The world faces a growing threat of abrupt and irreversible climate change. A large part of the Arctic Ocean has already warmed by more than 4°C above preindustrial levels. There has been an increase in climate-related incidents such as hurricanes, earthquakes and bushfires, leading to a loss of life, jobs and habitation. The harrowing scenes of the recent Californian or Australian fires may be a harbinger of a ‘new normal’. Are we going to be equally slow to heed calls for change, until a global climate emergency forces us to act?

The financial sector has a key role to play. Financial institutions fund the activities of the companies contributing to global warming and environmental damage. When making decisions on loans and investments, the financial system must fully consider the cost of economic activities that cause environmental destruction, pollution and biodiversity loss. The sector must be better prepared to deal with systemic risks, including climate and other environmental hazards.

Central banks are showing greater awareness of sustainability risks and acknowledging the need for them to help align the financial system with sustainable development. Last month, a survey by the Basel Committee on Banking Supervision revealed that the majority of its membership considers it ‘appropriate to address climate-related financial risks within their existing regulatory and supervisory frameworks.’

Many countries are considering introducing disclosure requirements for climate-related financial risks, as suggested by the Task Force on Climate-Related Financial Disclosures, as well as micro and macroprudential instruments to mitigate these risks. A number of central banks – including the Bank of England, De Nederlandsche Bank and the Banque de France – are developing climate stress tests for their financial systems.

But calls have emerged from the financial industry to delay prudential measures aimed at addressing climate risks. Without doubt, this is a period of great stress for our economies and the financial sector, and pragmatism and flexibility are needed to manage this situation where so much is at stake. But the crisis must not be used as an excuse to undermine efforts by central bankers and financial supervisors to climate-proof financial systems. If anything, the pandemic should strengthen their resolve to speed up efforts to integrate environmental and climate risks in financial decision-making to prevent the next crisis.

The central policy challenge in managing the pandemic and climate crisis is the same – we must make rapid progress in mitigating risks in the face of deep uncertainty and make our societies and economies more resilient. The financial sector will have to play a key role in this.

Aziz Durrani is Senior Financial Sector Specialist at the South East Asian Central Banks Research and Training Centre. Ulrich Volz is Director of the SOAS Centre for Sustainable Finance and Reader in Economics at the School of Oriental and African Studies, University of London.

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