Central Bank publishes research outlining key climate risk channels for the economy

• Climate change risks to households and businesses will vary considerably, depending on factors including the location of physical assets, energy efficiency, and individual behaviours.
• The financial sector will be impacted through changes in financial asset values and the effects on businesses and households.
• Long-run physical risks can only be reduced through policies that support a rapid and deep decarbonisation of production and consumption.

The Central Bank of Ireland has today (7 September 2022) published a Financial Stability Note, “Climate Risks in the Financial System: An Overview of Channels, Impact, and Heterogeneity” (PDF 1.02MB), authored by James Carroll. The Note looks at how physical and transition risks might translate to the real economy and impact households, businesses, and the financial sector.

The Note outlines that, in order to reduce long-run climate and weather-related damage, significant changes will be required in global energy efficiency and supply. The speed of this transition will depend on government policy. Policy approaches may include measures such as carbon taxes, to increase the cost of using older, polluting technologies; grants to reduce the cost of investing in existing energy-saving technologies; and energy labelling and emissions disclosure regulation to remove information gaps for all market participants.

The Note finds that household financial resilience may be affected by changes in income, energy costs, and individual physical risks – for example, the likelihood of flooding. Household vulnerability to rising energy prices will vary, influenced by factors including the individual demand for energy services, the size of a property, and the energy efficiency of technologies and vehicles.

Similar factors affect business resilience. Changes in energy costs will depend on the carbon intensity of the sector’s inputs and production methods, while revenue will be affected by consumer preference and sensitivity to energy-driven price changes. Access to finance is another key consideration for business as, with increasing levels of business emission disclosure, bank and investor risk appetite and profitability expectations may vary.

The Note also considers physical and transition risks in a specifically Irish context. It finds that severe and more frequent flooding is a key physical risk for Ireland. The rate of increase in flooding is highly uncertain, although it is clear that the risk itself will increase. Depending on the rate of flood adaptation, this may have implications for insurance decisions and, in turn, property values. The emission-intensity of the economy will decline with technological and behavioural change, although the speed and scale of such changes is unprecedented, and therefore uncertain. Furthermore, given that Ireland is a relatively open economy, transition risks from abroad will likely be more prominent here. The Note indicates that continued in-depth analysis in this area will be required in order to measure and monitor risks for the economy and to the financial sector.