Regulators Doing What They Shouldn’t
I felt spoiled for choice when it came to a topic with which to preface this week’s Capital Letter. Dogecoin went quite a long way toward the moon, the U.N.’s secretary-general has pushed for a “solidarity” or wealth tax, and digging further into the details of the administration’s planned new corporate-tax regime produced yet more nasty surprises.
That said, I think that it’s worth continuing to watch how the regulatory state continues to push ahead with its climate agenda in a way that bypasses the normal democratic process — and is still not subject to enough scrutiny.
Over the past decade, financial regulators have used stress tests to measure banks’ exposure to anything from losses on derivatives to fat-finger trades and cyber crime. Now, they have a more complex target in sight: assessing banks’ vulnerability to the effects of climate change.
This year, the Bank of England and the European Central Bank are running first-of-a-kind thematic stress tests of their banks’ exposure to everything from freak weather events to the decline of industries such as heavy manufacturing and traditional energy. In the US, the Fed has said it is in the very early stages of considering climate scenarios to assess the longer-term risk of climate change to the broader financial system.
It is worth noting how these stress tests are not only concerned with the effect that climate change may or may not be generating (such as those “freak weather events”) but also with the harm to certain industries caused by policies designed to slow climate change, harm that central banks may make worse with their own contribution to a concerted effort (supported by activists, “socially responsible” investors and all the rest) to increase the cost of capital for climate sinners.
The Financial Times (my emphasis added):
In late 2019, the BoE said the goal of this year’s climate exercise would be to achieve a better understanding of the financial risks that banks face from climate change, how their business models could be affected and what they are doing to mitigate those risks. “The BES [biennial exploratory scenario test] will focus on sizing risks rather than testing firms’ capital adequacy or setting capital requirements,” the BoE said.
According to Patrick Amis, director-general at the ECB with responsibility for supervising large institutions, the tests are to assess banks’ “resilience in certain scenarios and indeed to make them think about this, and make them start taking measures to adapt”.
Though preliminary results point to a “major source of systemic risk”, the ECB’s final report, due in July, is unlikely to hit institutions as hard as the ECB’s more familiar stress tests. Those can result in banks having to raise billions of euros in extra capital.
“In some cases, I imagine we will end up with qualitative requirements and possibly quantitative requirements if needed, but certainly not across the board,” Amis says.
And what were those preliminary results?
From a Financial Times report in March:
The European Central Bank has identified “a major source of systemic risk” in the preliminary results of its economic stress test to gauge the impact of climate change on 4m companies and 2,000 banks over 30 years.
Luis de Guindos, vice-president of the ECB, summarised the findings in a blog post on Thursday, saying: “In the absence of further climate policies, the costs to companies arising from extreme weather events rise substantially, and greatly increase their probability of default.”
Thirty years! One can only be amazed by the powers of prediction that the ECB, which so miserably failed to anticipate the euro-zone crisis, has now developed.
And (again, emphasis added):
His warning came shortly after another senior executive said the ECB was prepared to raise the amount of capital required at any banks considered to have particularly high levels of climate…
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