Market risk

Sergio Scandizzo and Tony Hughes

INTRODUCTION

In recent years, there has been a growing interest in the connection between climate change and the financial system. Private entities such as firms, banks and asset managers, along with public institutions such as central banks and financial regulators, are trying to comprehend the impacts of climate change and how the shift to a carbon-free economy could affect economic and financial stability. The main concern is that a combination of climate-related factors, such as sudden policy changes after extreme climate events, could lead to financial losses for companies and financial distress for households, which might then affect financial institutions through defaults and reduced market value. If this drop in asset prices is substantial enough, it could trigger a financial crisis with widespread economic and social consequences, known as a “Green Swan” or “Climate Minsky moment”. However, it is still uncertain how probable such a scenario may be. This depends not only on specific future events but also on how much current asset prices already factor in climate-related risks.

According to a 2023 Risk Survey by BankDirector (2023), only 21% of the respondents reported that