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Sizing the costs if the fossil fuel bubble bursts
15/2/2023
News
While efforts have been made to shore up the stability of the global financial system since 2008, regulators are lagging behind in implementing rules that adequately mitigate the risks of climate change and net zero on banks and insurers. So says a new report that suggests that without robust capital requirements in place, the socio-economic impacts of a fossil fuel-led financial crisis could be severe, with huge job losses predicted and a global bailout of $4.9tn potentially required to keep banks afloat.
Academics and economists have warned for many years about the growing risk of a fossil fuel stranded asset bubble. This means investments in oil, gas or coal exploration and extraction projects could suddenly have their value wiped out if demand drops as a result of climate change mitigation policies, changes in consumer preferences and technology developments.
A sudden drop in the value of fossil fuel assets could cause borrowers to default on their debts, in turn leaving banks and insurers insolvent and causing knock-on effects across the financial markets, warns the new report commissioned by the Sunrise Project for the One for One campaign.
‘Despite the clear threat of climate change and the urgent necessity of meeting net zero targets, banks and insurers around the world continue to finance new fossil fuel projects, through lending, insurance, and both direct and indirect investment,’ says the report. It goes on to claim that: ‘While efforts have been made to shore up the stability of the global financial system since the 2008 global financial crisis, regulators are lagging behind in implementing rules that adequately mitigate the risks of climate change and net zero on banks and insurers.’
As a result, the One-for-One campaign is calling for a 1,250% risk weighting for capital requirements to be applied to all financing of new fossil fuel exploration and extraction projects such that for every dollar invested in fossil fuels, financial institutions have one dollar of their own funds to cover the risk. The campaign also calls for a 150% risk weighting to be applied to existing fossil fuel assets.
‘These measures will prevent the build-up of systemic climate risk across the financial sector by raising the costs of providing capital for fossil fuel financing relative to clean energy, incentivising investment in the net zero transition and discouraging new fossil fuel production,’ claims the report. ‘Crucially, the rules will also protect against a global financial crisis stemming from a collapse in the value of fossil fuel assets, as banks and insurers will have the capital buffers in place to absorb any losses.’
The report gives a global estimate, relative to the 2008 housing market crisis, of how bad a financial crash may be in terms of job losses and the impact on public finances if the fossil fuel bubble bursts, unless capital requirement regulations are tightened.
While the actual date of any such crisis and exactly how it might unfold in the markets is impossible to forecast, the report takes 2030 as the presumed year of a crash. It also takes in two scenarios for global warming – either a trajectory that sees a 2°C global temperature rise by the end of the century, or 3.5°C.
The report suggests that, under a 2°C global warming scenario and without robust capital requirements in place, the socio-economic impacts of a fossil-fuel led financial crisis could be severe, with over 13.6mn job losses predicted and a global bailout of $4.9tn potentially required to keep banks afloat.
