The economy could face a 2008-style crisis if fossil fuel assets collapse

What’s happening? Over 13 million jobs could be lost and $4.9tn spent on bank bailouts if the global financial system does not reserve enough capital against climate-related losses, according to a report by the One-for-One Campaign. The report analysed the potential financial chaos that could occur if fossil fuel assets collapse in value and said the consequences would be on par with the 2008 financial crisis. The campaign has called for regulators to require banks and insurers to hold a dollar in reserve for every dollar invested in fossil fuel-related assets. Such a requirement would “act as a brake on fossil fuel financing”, while ensuring financial institutions can cope with losses if loans collapse, the report added. (Manifest Climate)

Why does this matter? A sudden drop in the price of fossil fuel assets could lead to borrowers defaulting on their loans and consequently leaving banks and insurers insolvent. Despite this, many banks are continuing to finance fossil fuels – a recent report found that 29% of GFANZ members still provide finance to the world’s largest fossil fuel developers.

What can be done? The One-for-One campaign calls for a 1,250% risk weighting for capital requirements to be applied on all financing of new fossil fuel exploration and a 150% risk weighting for existing fossil fuel assets. The campaign said these measures will increase the costs of capital for investing in fossil fuels relative to clean energy, incentivise greater investment in the net zero transition and hinder new fossil fuel production.

These rules would also protect against the risk of a financial crisis caused by a drop in the value of fossil fuel assets. The report said that the One-for-One rule may help avoid up to 18,700,000 job losses and that countries slow to adopt the rule will be impacted the most.

NGOs call for action – Following the release of the report, a group of NGOs including Reclaim Finance, ShareAction and Greenpeace wrote to members of the Committee on Economic and Monetary Affairs (ECON) calling for the introduction of the ‘One-for-One’ capital rule. The NGOs said this rule will protect against any careless risk-takers that disregard the EU’s climate commitments and ignore a variety of transitional and physical climate risks.

Despite the letter, at the recent vote, ECON excluded the proposal calling for the One-for-One rule. In a separate vote, the committee approved measures that will consider climate transition plans and targets when evaluating regulatory prudential requirements from banks.

The limitations of green capital requirements – A research paper last year highlighted some of the limitations of green capital requirements. The report said that higher capital requirements for dirty loans can reduce green lending and that using capital requirements to reduce emissions may require sacrificing financial stability.

Additionally, Alex Edmans, Professor of Finance at London Business School, noted that if climate risk is investment risk then credit ratings should take this into account, this would then affect risk-weighted assets and consequently capital requirements, therefore there is no need for an additional green adjustment.

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