From drought to flood - climate risk and the RBNZ

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Reserve Bank governor Adrian Orr has warned against ‘short-termism’ and ignoring social and environmental harm in a speech to company directors.

Saturday, November 4th 2023, 6:24AM 2 Comments

by Andrea Malcolm

Outlining the RBNZ’s climate change response he said the RNBZ’s financial stability objective compels it to adequately prepare for potential climate-related risks to come. It does so through policy settings and prudential supervision and oversight of NZ’s financial institutions.

He said the RBNZ is aligned with central banks all over the world in taking the financial risks of climate change seriously. “Long term financial stability must not fall victim to short-term thinking.”

The RBNZ is one of more than 120 central backgrounds world-wide that have joined the Network for Greening the Financial System (NGFS) to better understand and respond to this risk.

Orr referred to his Australian counterpart Governor MIchele Bullock who earlier this week said climate change and the responses taken will have broad ranging implications for the economy, the financial system and society at large.

Stress testing and guidance

The RBNZ recently began including climate-related risk in its stress testing to help itself and the banking and insurance sectors build capacity in assessing the impact of climate on the country’s financial stability, said Orr.

Since 2021 stress testing with the insurance and banking sectors has incorporated severe weather events including drought, coastal and inland flooding, and emissions pricing and potential impacts on agriculture.

The RBNZ has also worked with the XRB and FMA to put out guidance on managing climate risk to its prudentially regulated entities - registered banks, licensed insurers, licensed non-bank deposit takers, and financial market infrastructure operators. The aim is to help them manage the risk efficiently and effectively, regardless of whether they fall under the mandatory climate risk disclosure regime.

Working with scientists and Māori

Orr said in its supervisory role, the RBNZ assesse, monitors and supports prudentially regulated entities to be financially stable and adhere to rules and regulations.

Climate risk is a priority theme of the Council of Regulators (CoFR) and it is working on its supervision of climate risk with the FMA. It is also collaborating with scientists on finding data gaps and understanding how climate risk works.

The RBNZ and regulated entities are also working with Māgori and iwi who have distinct challenges, opportunities and aspirations in transitioning to a low emissions economy, especially as Māori economy is heavily invested in land-based sectors with high emissions profiles, he said. Collective work is underway to improve Māori access to capital to help reduce transition risk.

He gave the example of Ngāti Porou, Ngāti Tuwharetoa and Te Arawa having taken up collective group insurance policies for marae, lowering costs through pooling and improving financial buffers against extreme weather events.

Future plans

The RBNZ has committed to developing its first climate-related disclosure report. This will include looking at its core functions as a central bank including monetary policy, its balance sheet, currency and payment systems and its actions as a prudential regulator and supervisor.

It is looking at how climate change, the macroeconomy and monetary policy intersect. “Disruptive supply-side shocks like those from Russia’s invasion of Ukraine and the pandemic foreshadow potentially similar supply-side shocks from worsening climate impacts and an economy in transition.”

Orr said on the physical risk side, evidence for the macroeconomic significance of drought in New Zealand is well established. But apart from the risks, we shouldn’t ignore the opportunities of transitioning to net zero.
Balance sheet

Orr said RBNZ’s balance sheet is mainly sovereign bonds for monetary policy implementation and foreign reserves management. Assessing a sovereign bond for climate risk exposure needs data and careful consideration, “especially when we are trying to minimise our credit and liquidity risks,” he said.

Work the RBNZ is doing with Banca d-Italia as part of the NGFS is a resource for this, with a sub-group researching new ideas and better practices for the central banks.

The RBNZ is also working on making sure that central bank money is available to the public when needed. Orr said Cyclone Gabrielle highlighted the “lifeline nature of cash and payment systems.” He said branch closures and reducing ATM numbers have made some retail banks more reliant on physical roading, data and electricity networks which are at increasing risk of disruption through climate change.

“The cash system will need to adapt over time to continue to meet the needs of New Zealanders, potentially including a new digital New Zealand dollar, to circulate alongside physical cash.”

On developing a sustainable financial framework, Orr threw his support behind the development of a taxonomy defining can and can’t be a sustainable investment or financial instrument.

He says this work is vital where concerns around greenwashing could undermine investment in the shift to a climate-resilient economy.

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