Natural disasters, climate change and potential impacts on financial stability have been increasingly attracting the attention of regulators around the world. Climate-related risks that impact the financial sector can be split into two categories: physical and transition risks.
Physical risks include those related to threats from more powerful and regular natural disasters, leading to loss of property, assets and infrastructure. These risks can negatively affect public finances, financial and insurance sectors, individuals and businesses. The insurance sector, for example, will have to absorb the higher costs associated with the impact of natural disasters on its obligations and assets.
Mitigating physical risks can lead to transition risks. These include potential financial losses in the value of investments changing. This could be because of actions adopted to address climate change or consumer and investor behaviour changing towards environment-friendly practices.
It is crucial that measures to alleviate the effects of climate change are developed and implemented. Arab countries have made valuable efforts to support initiatives that enhance environmentally friendly financial products. Several central banks in the region have encouraged commercial banks to adopt and develop pro-climate products and services. These efforts have been reinforced by the Arab Monetary Fund.
In June 2020, the AMF issued guidelines for central banks to deal with the implications of natural disasters and climate change on the banking system and financial stability. This guidance emphasised the need for central banks to develop a comprehensive natural disaster management and governance framework. It also encouraged the building of a strategic partnership between central banks and the private sector in disaster recovery financing, as well as disaster risk reduction activities in general. This will lead to early contingency planning for natural disasters, reducing costs and losses that they may cause.
Coordination between stakeholders associated with the environment and natural disasters is key to the success of creating effective risk management in any country. The AMF principles highlight the importance of building a co-operative framework that streamlines coordination and information exchange between central banks, research centres and relevant environmental institutions.
Finally, central banks should facilitate environmentally friendly projects, with financing at competitive interest rates for suitable maturities. This will promote sustainable and responsible financing, providing incentives to commercial banks and project owners in a thoughtful manner.
Abdulrahman Al Hamidy is Director General Chairman of the Board of the Arab Monetary Fund.