Central bank is becoming an important player in the climate fight
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The Bank of Canada isn’t the greenest of the major central banks. That distinction probably goes to the Bank of England, which earlier this year received orders from the British government to take climate change into account when purchasing financial assets.
For now, Governor Tiff Macklem’s sole mandate remains taming inflation. Having a singular focus allows him to steer clear of political traps. A climate remit like the one given to the Bank of England would complicate life for Canada’s central bank, because oil companies are big issuers of corporate debt. The Bank of Canada’s emergency Corporate Bond Purchase Program specifically sought to build a portfolio that mirrored the broader market. That meant buying bonds that had been issued by companies such as Canadian Natural Resources Ltd. and Suncor Energy Inc.
Still, the Bank of Canada is becoming an important player in the climate fight. It’s creating a role for itself as an honest broker in a country that continues to struggle to find a consensus on how to meet its Paris commitments. Macklem and his deputies on the Governing Council used their annual Financial System Review (FSR) to state explicitly that “assets exposed to climate-related risks are generally mispriced,” meaning that banks, asset manager, and other owners of such assets might not be as wealthy in reality as they currently appear to be on paper. Policy-makers called it a “vulnerability” that could result in a financial crisis if prices correct too quickly.
The Bank of Canada is also ramping up its research agenda. The FSR included the results of a deep study of natural disasters in Canada based on data that dates to 1900. Using artificial intelligence, the central bank determined that about 40 per cent of the country’s total household debt is held by households living in parts of the country that face “high exposure” to wildfires and other such catastrophes.
In other words, one bad weather event could trigger a cascade of bankruptcies that would ripple all the way to Bay Street. The financial system’s exposure to climate-change risk is broader than most investors realize. That’s why the oil-industry bonds that the Bank of Canada purchased while it was fighting the COVID-19 crisis were purchased at a premium. Investors soon will demand a greater risk premium. They probably are doing so already.