Climate Change

Financing fossil fuels risks a repeat of the 2008 crash. Here's why

Smoke rises out of factories in Thailand's Chonburi province, about 90 km (56 miles) southeast of Bangkok February 1, 2007. The Intergovernmental Panel on Climate Change (IPCC) will release a long-awaited report assessing the human link to pollution, global warming and climate change in Paris on Friday. A draft of the report, which draws on research by 2,500 scientists from more than 130 countries, projects a big rise in temperatures this century and warns of more heatwaves, floods, droughts and rising sea levels linked to greenhouses gases released mainly by the use of fossil fuels

Is continued investment in fossil fuels leading us towards another financial as well as ecological catastrophe? Image: REUTERS/Sukree Sukplang - GM1DUNAUBRAA

Jennifer Morgan
State Secretary and Special Envoy for International Climate Action, Federal Foreign Office of Germany
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Climate Change

This article is part of: World Economic Forum Annual Meeting
  • Financial institutions are still too complacent about climate change.
  • There are strong parallels with the mistakes that led to the last financial crisis.
  • Policy-makers and regulators must act now to avert another catastrophe.

To continue financing fossil fuel expansion is today’s equivalent of betting the bank - and the global economy - on subprime mortgage-backed securities over a decade ago; it is fuelling a crisis that, even if it generates short-term profit, will inevitably cause economic catastrophe alongside the climate emergency.

Since the Paris Agreement was signed, 33 major global banks have collectively poured $1.9 trillion into fossil fuels. Recent analysis from WRI indicates that from 2016-2018, the average annual level of fossil fuel finance from banks with active sustainable finance commitments is nearly twice the annualised amount of such commitments. Worrying echoes of the 2008 financial crisis can be heard in this focus on short-term profit accompanied by inadequate regulatory oversight and an underestimation of the level of risk being run.

An unduly narrow focus on ‘transition risk’ among the categories of climate-related financial risk, coupled with a lack of meaningful political action, has also led to complacency among financial institutions regarding climate change.

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The far more significant - and, on current trajectory, the more likely - risk comes from the systemic consequences of failing to meet the Paris Agreement goals. It comes from failing to achieve a rapid and orderly transition to a low-carbon economy. This is ‘failure to transition risk’, or what Mark Carney, the outgoing governor of the Bank of England and newly appointed UN Special Envoy for Climate Action and Finance, recently termed “the catastrophic business as usual scenario”.

Politicians, companies and financial institutions are not taking action either commensurate with the scale of the climate emergency or at a pace that reflects the limited time available to meet the Paris goals.

In its recent progress report, Climate Action 100+ - the largest investor climate initiative - revealed that after two years of engagement, only 9% of the 161 target companies have emissions targets in line with a 2˚C or lower target. As Carney said in his September 2019 Climate Week speech: “Like virtually everything else in the response to climate change, the development of this new sustainable finance is not moving fast enough for the world to reach net zero.” The world is on track to exhaust the carbon budget associated with a rise of 1.5˚C by 2030.

We need $90 trillion over the next 10 years to achieve the goals of the Paris Agreement and the 2030 Agenda for Sustainable Development. Yet fossil fuels still attract nearly three times more subsidies than climate solutions.

Against these finance flows, the UN-backed Principles for Responsible Banking - which have 130 signatories - appear incremental in the extreme. Without concrete and ambitious targets, banks risk turning this initiative into yet another greenwashing tool.

Although progress is being made, it is happening far too slowly
Although progress is being made, it is happening far too slowly Image: TPI, Climate Action 100+

Yet policy-makers seem determined to pursue a voluntary, carrot-based approach to tackling the greatest systemic risk building up in the global economy. As emissions continue to rise, corporate progress remains incremental, and the window for limiting global temperature increases closes. It’s time to acknowledge this approach is not working. It’s time to rewrite the rules to secure the transformational change required.

Climate action necessitates the restriction of negative activities, not just the incentivization of positive ones. In line with their existing mandate on financial stability, central banks must take more action to address systemic climate risk. Regulations should be introduced to shift lending and investment out of high-carbon sectors. Higher capital requirements - a ‘brown penalty’ - should be applied to fossil fuel and other high-carbon lending. Central banks should exclude fossil fuels and other energy-intensive industries in their asset-purchasing programmes, and should prioritize those sectors advancing the transition to a low-carbon economy. Central banks should follow the lead of the Bank of England and Dutch Central Bank and include a range of climate scenarios in financial institution stress tests.

To avoid any misinterpretation, governments should provide central banks with an explicit mandate to extend their horizon on financial stability to fully encompass climate risk and to be a force for decarbonization. Reporting under the Task Force for Climate Related Financial Disclosure should be mandatory. Governments should end supply-side subsidies and export credit financing for fossil fuels and incentivise investment in renewable energy.

Regulators missed the warning signs in the 2000s. Banks driven by short-term profit did not understand or ignored the risks, and most of those that survived that crisis did so because the taxpayers of the world bailed them out.

Are financial institutions going to make - and be allowed to make - the same disastrous mistake? If they are, this time no bailout will be possible - for them or the planet.

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Climate ChangeDavos AgendaFinancial and Monetary SystemsCorporate Governance
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