IMF, financial institutions, climate change and stability

The International Monetary Fund (IMF), in its latest Global Financial Stability Report with the title “Connecting the Dots Between Sustainable Finance and Financial Stability, calls the attention of on financial institutions and other firms to Environmental, Social and Governance (ESG) principles to guard against losses arising from climate change. Chima Nwokoji reports.

The International Monetary Fund (IMF) has, once again, extended its call on financial institutions and other firms to pay attention to environmental, social, and governance (ESG) principles that are becoming increasingly important for borrowers and investors.

It specifically noted that these issues, known as sustainable finance may have material impact on corporate performance (profit) and may give rise to financial stability risks through loans given out by banks and activities of insurers as well as  large losses from climate change

The IMF made this known in its latest  Global Financial Stability Report titled: “Connecting the Dots Between Sustainable Finance and Financial Stability.”

It argued that integrating environmental, social and human factors into firms’ business models will “help mitigate risks.”

While discussing the link between sustainable finance and financial stability, and suggesting policies for the way forward, the multilateral institution highlighted that more and more investors are looking at issues like unsafe working conditions, use of child or forced labour, environmental impact on protected areas, as well as factors beyond traditional financial analysis when directing their money.

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Identifying two main channels of risks, the IMF stressed that  physical risks include damages from weather-related events and broader climate trends, while transition risks arise from changes in the price of stranded assets (that is, assets such as coal and oil that will not be used during the fossil fuel phase-out).

These, it said,  relate to the economic disruptions from climate-related policies, technology, and market sentiment during the adjustment to a lower-carbon economy.

It noted that financial risks from climate change are difficult to quantify, but most studies point to economic and financial cost estimates in trillions of dollars.

Already, insurance losses from climate-related natural disasters such as droughts, floods, and wildfires have quadrupled since the 1980s, the report reveals.

According to the IMF, though asset prices may not yet fully internalise climate risk and the transition to a cleaner economy, individuals or firms that delayed recognition of these risks could land in a ‘cliff-like’ moment when investors suddenly demand this risk be priced into asset values with potentially detrimental consequences for financial stability.

Sustainable finance aims to help society better meet today’s needs and ensure that future generations will be able to meet theirs too.

According to the report, sustainable finance incorporates ESG principles into business decisions and investment strategies and covers many issues from climate change and pollution to labour practices, consumer privacy, and corporate competitive behaviour. The IMF stated that efforts to incorporate these kinds of considerations in finance started 30 years ago, but accelerated only in recent years.

“Environmental, social, and governance issues can have a material impact on firms’ performance and on the stability of the financial system more broadly. Environmental catastrophes have caused large losses to firms and insurers.

“Governance failures at banks and corporations contributed to the Asian and the global financial crises. Social risks, for example, in the case of inequality, may tempt policy-makers to unduly facilitate household borrowing for consumption and could lead to financial instability over the medium-term,” it read in part.

It noted that elements of ESG principles (particularly on corporate governance) have long been incorporated in portfolio investment strategies, and today, the assets under management of ESG-related funds range between $3 trillion and $31 trillion, depending on the definition.

The report stated that applying principles of sustainability began in equities markets through investor activism as an attempt to influence corporate action, and later extended to fixed income markets, primarily with bonds that finance environmental projects, so-called green bonds.

Quoting Victor Hugo, “Nothing is as powerful as an idea whose time has come,” the multilateral institution stated that urgent and decisive policies are needed in four key respects for sustainable finance to effectively address critical risks. These areas are: Standardisation of ESG investment terminology, as well as clarifications of what activities constitute environmental, social, and governance; consistent disclosure by firms to incentivise investors to use ESG data; multilateral cooperation to encourage participation from more countries and avoid setting different standards; implementation of policies incentivising investment in sustainability, and requiring public disclosure of the cost of inaction.

However, it is gratifying to know that financial institutions are at various levels of adoption of the Nigerian Sustainable Banking Principles (NSBP).

Nigerian Tribune reports that though the banks are at varying levels of engagement with these principles, and with sustainable banking in general, significant progress has been made since 2013.

For instance, Deloitte Nigeria surveyed 18 of the largest banks to understand how they have adopted sustainable banking principles, what their experience has been and what they need to overcome the challenges they have experienced so far.

One of the key highlights from the survey is that all the respondent banks have developed an Environmental and Social (E&S) framework to guide their sustainable banking activities and about 95 per cent of them have implemented E&S initiatives in recent times.

The IMF says it will continue to incorporate ESG-related considerations, in particular related to climate change, when critical to the macro-economy through its multilateral surveillance work, such as in the Fiscal Monitor, future Global Financial Stability Reports, as well as its bilateral surveillance efforts.

Nigerian Tribune