Supervisor's remarks at the "Environment 2050" conference on climate developments and the importance of regulation and the banking system in the process
I am very pleased to participate here today at this very important conference.
That may seem like a standard ceremonial opening line, but the truth is that it is not something I say lightly. The topic of this conference is truly important to me, because it is visceral for us, and I am truly happy to take any opportunity I have to increase awareness of the potential implications of climate change, and the role that we—all of us—have to play in this matter.
Climate change poses special challenges for us, which we are facing without any prior experience. This is true regarding the necessity of reducing the pace of climate change, as well as regarding the need to prepare for what may be difficult to prevent. These two paths of action are a national task of the first order. I am convinced that through cooperation by all relevant players—the government, regulators, the business sector, and the general public—we must and we can do much to progress on these two paths.
As you know, one of the main difficulties in dealing with climate change is significant uncertainty. It is very difficult to predict unprecedented and constantly changing phenomena, which have a complex environmental-socioeconomic dynamic and feature chain reactions. There is no model that can provide us with a complete picture, and there is no single scenario that can bring into sharper relief what we must prepare for. But it is very clear that in the coming decades, climate change may have an impact on all areas of life—society, the economy, health, national security—basically everything. Our fresh experience from the COVID-19 crisis is a tangible example of the scope and power of the effect that an environmental trigger may have. Many medical journals have shown, even in the context of global warming—that one of the main concerns is a serious health crisis, mainly in view of the creation of conditions for the spread of disease.
There is broad agreement around the world that the climate crisis, similar to the COVID-19 crisis, is due to a failure that cannot be corrected simply by market forces, and therefore requires government intervention. Central banks and the supervisors responsible for financial stability also have a significant role to play in this regard, but it is important to understand that the activity of financial regulators is a complementary action, and that it cannot replace activity that is required from government.
The link between climate change and economics and finance is well-known, but I would still like to spend a few works to bring it into sharper relief.
Taking a broad economic view, climate change may lead to interruptions in economic activity, the erosion of nutritional security, migration problems, unemployment, creating new poverty centers, and a “lack of climate justice” derived from the over-vulnerability of emerging countries and of weaker population groups.
From a banking standpoint, there are two types of risk connected to climate that are threatening banks. The first is trivial—the risk of physical damage from climatic phenomena such as floods, fires, and rising sea levels. The second risk type is transition risk, which is basically due to the global response to the climate crisis, mainly the transition to low-carbon economies. In this transition, governments change laws and taxation rules, technology changes, and of course, public tastes also change. These changes are expected to create significant acclimation challenges that may be larger if the transition is less gradual and less controlled.
The banks’ exposure to these two types of risk is mainly indirect. It is created through the exposure of banks’ customers to climate risks, and through the potential impact on the value of collateral and of investments. Essentially, the banks’ exposure to climate risks is reflected in an increase in classical risks—credit, market, and liquidity risks, operational risks, and all the other well-known risks.
But not everything is negative. The other side of the climate crisis is opportunity. There is a growing new economic perception in the global discourse that we must reconsider our unbounded drive for economic growth and move to economies that are measured by quality of life and that are based on the understanding that we must protect the world for our continued existence. In this spirit, and in view of the developing climate crisis, more and more governments and businesses—financial and real—are committing to ESG targets, particularly climate targets, and striving for a better world.
In other words, more and more key players in our society understand that “we must reset!”. We must reset ours understanding of the enormity of the situation and the required response. We must reset our society to net-zero emissions. Both we, as the banking regulator, and the banks are also partners in this conceptual change. Many of the banks are voluntarily adopting environmental and social principles, working to finance renewable energy, developing green investment products, and internalizing the increasing expectation of responsible banking. This is on our watch, and therefore our responsibility.
As the body that supervises the banks, on the side of ensuring stability, the Banking Supervision Department also encourages the banks to view themselves as partners in designing the socioeconomic fabric of the economy and of society, and to maximize the good of all interested parties—increasing value for customers, investing in employees, acting ethically and fairly, supporting the community, and protecting the environment. In other words—implementing what is generally called “conscious capitalism.” I believe with all my heart that profitability attained while creating environmental or social value has greater strategic value than the profitability of the “old world”.
In this context, in the past decade Harvard University has developed the term “shared value”. Behind this term is the concept that in order to remain competitive in today’s world, companies need to do more than just create profit. They must create shared value, meaning they must create economic value in a way that also responds to social or environmental needs. This will lead to a deep change in strategic thinking and in the business model. Through this conceptual change, businesses set themselves apart, open new growth paths for themselves, and attain better bottom lines. From a business standpoint, the creation of shared value is a way to gain a significant competitive advantage. Alongside this, shared value can “increase the pie”, which provides important value on its own.
As we know, one of the barriers to internalizing environmental targets and integrating it into economic and business thinking is the need for long-term vision. Mollie Beattie, a US government official who contributed much to environmental protection, argued that the only conflict is between short-term and long-term thinking. For someone who thinks long-term, not only are the environment and the economy not in conflict, they are converging. In the long term, if a certain activity is not environmentally friendly, it is also not economical. I believe greatly in this concept.
I believe that one of the roles of government and regulators regarding climate change is to create the incentives and understanding for a long-term view. According to assessments, the volume of investment with the aim of attaining long-term targets is significantly lower than the cost of “doing nothing”. In my view, doing nothing is not a realistic alternative.
The Bank of Israel is working on the issue of environmental and climatic risks in line with the developing global trends and standards, and is constantly monitoring the knowledge and experience that is being accumulated. The Banking Supervision Department is participating in roundtables and cooperative projects with interested parties both in Israel and abroad, including government ministries, regulators, experts from the private sector, and leaders from academia.
The Banking Supervision Department is currently formulating an up-to-date and comprehensive banking directive on climate risk management, which is based on the recommendations of the Basel Committee. This is a principle-based directive that will deal, among other things, with aspects of corporate governance, internal controls, establishing a risk management framework, and conducting stress analyses. A draft of the directive has been sent to the supervised entities, and our aim is to publish the final directive in the first half of 2023. In the meantime, Supervisor’s Letters sent to the banks require them to identify, assess, and manage environmental risks in accordance with the standards being developed worldwide. Through these letters and the continuing dialogue with the banking system, the Banking Supervision Department has raised the awareness of the banks’ management and boards of directors regarding the importance of this matter. As part of the international community, the Banking Supervision Department is trying to balance the expectation of development of optimal methods and tools for managing climate risks with the necessity of acting immediately with the tools and knowledge that we have.
In terms of disclosure, the Banking Supervision Department was at the global forefront in 2011, when it required the banks to publish a periodic report on corporate responsibility, the name of which was recently changed to the ESG report (environment, society, and governance) as part of our adjustments to global best practices. We hope that this disclosure and transparency will encourage the reporting entities to internalize ESG considerations in banking activity itself and in the overall relationships between the various interested parties.
We are also monitoring developments in the global stress scenario field, and we will be formulating a uniform climate stress scenario as a learning scenario that will be used both by the Banking Supervision Department and by the supervised entities to analyze risks already in 2023. In addition, as part of advancing the issue, we are in the midst of a broad survey examining the banking corporations’ preparedness and exposure to climate risk.
The banks in Israel and abroad are in the process of developing the necessary knowledge and professional abilities, assimilating environmental and climate considerations in their business strategy, and including climate risks as part of their risk management program. There are still significant limitations to implementation, but there is already a practical discussion of those aspects, mainly in the area of credit.
However, as I have noted, and it is important to emphasize, we cannot expect the financial systems to lead the process of transitioning to a green economy, even though the system must prepare, develop capabilities, and assess climate risks and exposures. The most efficient tools to redirect the economy to the desired direction are still held by governments.
Before I conclude, I would again like to discuss climate change from a broad viewpoint, because we are all part of the joint effort globally and domestically. As some of you may have already read, according to the 2023 report now being published by the World Economic Forum, environmental and climate risks were again ranked as the number 1 threat we face in the coming decade. These are also the risks that we are least prepared to face. According to the report, which is based on assessments by more than 1,200 experts from academia, the business sector, government, and international organizations, the world is at a crossroads. The actions that we take or do not take today will determine our future, and we must make sure that our handling of existing crises does not take away from the long-term vision. A defensive, fragmented, crisis-oriented approach is short-sighted, and may extend the problem. In the global and domestic response to climate change, we must adopt a determined approach and a long-term vision.
To conclude, on a personal note, I again say that I believe we must and can make the necessary change. I view it as a mission to be part of this process that turns crisis into opportunity, and the Banking Supervision Department will do all we can to contribute to the shared effort. As I have noted, this is on our watch, and we must do all we can to protect our world and to ensure quality of life for future generations.
Credit: Liat Mendel