‘Green Swan’ event could trigger financial crisis: BIS

Climate change threatens to provoke “green swan” events that could trigger a systemic financial crisis unless authorities act against such risks, according to the Bank for International Settlements.
The analysis by officials at the Basel-based institution – often described as the central bank for central banks – adapts the “black swan” concept devised by Nassim Nicholas Taleb to describe adverse events outside the scope of regular expectations with wide-ranging or extreme impacts.
“Green swans or ‘climate black swans’ present many features of typical black swans,” said the authors, who include BIS Deputy General Manager Luiz Pereira da Silva. “Traditional approaches to risk management consisting in extrapolating historical data and on assumptions of normal distributions are largely irrelevant to assess future climate-related risks.”
Green swans are different from black swans because there is some certainty that climate change risks will one day materialise, which could endanger humanity more than financial crises, and they threaten even more complex and unpredictable chain reactions, the authors wrote.
The paper, published just after the world’s warmest decade on record, adds to a growing body of central bank-related analysis calling for authorities to better prepare for finance-related risks stemming from climate change.
Bank of France governor Francois Villeroy de Galhau, in an introduction to the paper, argued that “in order to navigate these troubled waters, more holistic perspectives become essential.”
The analysis reiterates often-made arguments that central banks alone can’t provide the needed solutions, but also acknowledges that climate change may lead such institutions into uncharted waters where traditional models will tell them little about the scope of the crisis at hand and careful decisions must be taken on how to engage.
“If they sit still and wait for other government agencies to jump into action, they could be exposed to the real risk of not being able to deliver on their mandates,” the authors argued.
Many central banks already contribute to the effort by monitoring climate-related risks through stress tests, incorporating environmental, social and governance criteria in pension funds, or working with banks on disclosing carbon-intensive exposure to assess potential financial-stability risks. Villeroy says that’s simply not enough however.
“The stark reality is that we are all losing the fight against climate change,” Villeroy said, advocating two solutions the European Central Bank could discuss in its upcoming strategy review: integrating climate change in all economic and forecasting models, and overhauling the collateral framework to reflect climate-related risks.
“If central banks are to preserve financial and price stability in the age of climate change, it is in their interest to help mobilise all the forces needed to win this battle,” he said.