Greening the financial system

The Central Bank this week launched a new roadmap to make Sri Lanka’s financial system more open to funding projects and policies crucial to improve climate resilience and combat climate change. 

Earlier this year, Sri Lanka was categorised as one of the top 10 countries for climate vulnerability by the World Bank. Sri Lanka is particularly vulnerable to climate-related natural disasters such as floods and droughts, which affects the poor disproportionately. Therefore, understanding the impact that climate change can have on a country’s fiscal performance and factoring those risks into policymaking has become important. For example, large scale droughts and floods in 2016 and 2017 helped miss deficit targets. 

Moreover, the public sector cannot meet the funding demands of building climate-resilient infrastructure. Therefore it is important that the financial system of the country, including banks and leasing companies, be encouraged to finance green projects and promote green policies to help Sri Lanka deal with the impacts of climate change.  

Extreme weather events impact health and damage infrastructure and private property, reducing wealth and decreasing productivity. These events can disrupt economic activity and trade, creating resource shortages and diverting capital from more productive uses to reconstruction and replacement. Uncertainty about future losses could also lead to higher precautionary savings and lower investment. 

Physical impacts are not just risks for the future; they are already impacting the economy and financial system today. Overall, worldwide economic costs from natural disasters have exceeded the 30-year average of $140 billion per annum in seven of the last 10 years. Since the 1980s, the number of extreme weather events has more than tripled.

Over a longer time horizon, progressive changes in the natural environment will impact the liveability of different regions, particularly if mean temperatures rise by more than 1.5 to 2°C compared to pre-industrial levels. This is due to the significant risks related to human health, food security, water resources, heat exposure and sea level rise.

Estimates suggest that absent action to reduce emissions, the physical impact of climate change on the global economy in the second half of the century will be substantial. The more sophisticated studies suggest average global incomes may be reduced by up to a quarter by the end of the century. In addition, the increased probability of disruptive events such as mass migration, political instability and conflict in these scenarios means that economic estimates are likely to understate the size and timing of the associated risks. If losses are insured, more frequent and severe weather events affect insurance firms directly through higher claims and their customers indirectly via higher premiums. If losses are uninsured, the burden falls on households, companies and ultimately governments’ budgets. A change in the debt repayment capacity of borrowers or a fall in collateral values can increase credit risks for banks and other lenders. A change in lenders’ projected earnings would also be reflected in financial markets, impacting investors and asset owners.Feedback loops between the financial system and the macro-economy could further exacerbate these impacts and risks. This is why greening the financial system is so important. Banks, leasing and insurance companies, as well as other non-bank financial institutions need to work to understand the risks created by climate change and adapt their business structures and strategies to building climate resilience, especially in the developing country.