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Publié le
Mardi 22 Septembre 2015
By Rens van Tilburg (Utrecht University) - Financial shocks can originate from ecological imbalances what justifies more careful attention by the financial regulators to this specific risk. A new macroprudential framework is proposed.
What Role for Financial Supervisors in Addressing Systemic Environmental Risk?

Since the 2007/2008 financial crisis, supervisors have developed a macroprudential policy framework: new mechanisms to identify systemic financial imbalances and new instruments to address them.

In this same period, an increasing number of studies have been published on financial shocks that originate from ecological imbalances, triggered by either intensified policies to protect ecological boundaries or due to the costs of crossing these ecological boundaries.

However, financial supervisors[1] have so far given little attention to this rapidly growing literature. A notable exception is the Bank of England that has put the potential impact of ecological imbalances on financial stability on its research agenda. This lack of attention for ecological imbalances allows systemic financial imbalances to build up and concentrate in certain financial institutions and markets.

In a paper with Dirk Schoenmaker of VU University and the Duisenberg School of Finance and Herman Wijffels of Utrecht University we explore the question whether this same rationale of the (still developing) macroprudential supervisory framework also applies towards the ecological imbalances to which the financial system is increasingly exposed.[2]

We propose an outline of a policy framework for the ecological dimension of macroprudential supervision: the intermediate objectives and indicators for ecological imbalances. We discuss the instruments to address these imbalances and the institutions best equipped for this task. Finally, the working of this macroprudential framework is illustrated in the case of carbon emissions.

The macroprudential policy framework

While fostering financial stability is the ultimate objective, intermediate objectives need to be specified to make macroprudential policy operational. The macroprudential strategy relates? intermediate objectives to indicators and instruments. The European Systemic Risk Board has identified four intermediate objectives, which aim at mitigating systemic risks to financial stability that follow from:

  • Excessive credit growth and leverage. Excessive credit growth has been identified as a key driver of asset price bubbles and subsequent financial crises, with leverage acting as an amplifying channel;
  • Excessive maturity mismatch and market illiquidity. Reliance on short-term and unstable funding may lead to fire sales, market illiquidity and contagion when the financial cycle turns;
  • Direct and indirect exposure concentrations. Exposure concentrations make a financial system (or part of it) vulnerable to common shocks, either directly through balance sheet exposures or indirectly through asset fire sales and contagion;
  • Misaligned incentives and moral hazard. This includes risks associated with systemically important financial institutions and the role of implicit government guarantees.

We distil four criteria for including asset classes as financial crisis prone and hence relevant for macroprudential supervision.

  • The first is the maturity of an asset. An abrupt change in the services of an asset with a long maturity can lead to a major downward adjustment of its price, as future services become less worthwhile;
  • The second criterion is the capital intensiveness of an asset. As the market value of an asset drops below its marginal cost price, the production of that asset will be halted leading to a realignment of resources in the real economy;
  • The third criterion is the economic share of an asset class. What proportion of the economy is affected?
  • The fourth and final criterion is the amount of debt financing of an asset. While equity can absorb financial shocks, failure on debt may propagate a financial shock.

The four criteria are cumulative. So an asset class needs to fulfil all criteria in order to be crisis prone.

Are environmental risks material for macroprudential supervision?

The first question is whether macroprudential policies should also target the ecological risks that are building up outside the financial system itself? Financial shocks may originate from ecological imbalances, triggered by either intensified environmental policies, technological breakthroughs (e.g. cheap renewable energy), and expectation of this in financial markets or due to the economic costs of crossing these ecological boundaries (e.g. climate change disrupting economies). In the case of environmental risks, adjustments may be severe and abrupt, leading to disorderly markets and substantial losses for financial institutions.

But are these factors material for macroprudential supervisors? Macro estimates of current ecological imbalances, as measured by the unpriced externalities, suggest they are. The average annual economic cost of human-induced environmental depletion was estimated at approximately $6.6 trillion in 2008, equivalent to eleven per cent of global GDP (UNEP FI, 2011). If environmentally unsustainable activity continues at this scale, the annual costs for the global economy will reach nearly $28.6 trillion by 2050, equivalent to eighteen per cent of global GDP. Of this, greenhouse gas (GHG) emissions account for a large and growing share of environmental costs, rising from 69 to 73 per cent between 2008 and 2050.

The cost of environmental damage[3] caused by eleven key industry sectors in 2010 was equivalent to forty-one per cent (KPMG, 2012) to over half (UNEP FI, 2011) of their pre-tax profits. Some sectors, such as food producers, would have no profits left if they had to pay the full cost of their negative environmental externalities (KPMG, 2012).

The existence of externalities as market failure is the ratio behind the new macroprudential policies of financial supervisors: to act on systemic risks that individual financial institutions have no incentive to act upon.

Focusing specifically on the case of the carbon bubble we find that the carbon intensive industry is capital intensive and the assets (e.g. power stations or car plants) are long-lived. The bursting of the carbon bubble, or a substantial increase in the carbon price due to a carbon tax, can thus lead to a major downward adjustment of the value of these assets. On the third criterion, we show that the carbon bubble affects a large part of the economy. Finally, we find that exposures to fossil fuel firms are largely debt financed (at 62 per cent). Utilities (including for energy) are also to a large extent debt financed, typically between 50 to 80 per cent. So a large swing in asset prices can lead to substantial losses on debt. We conclude that the carbon risk as to the financial system appears to tick all boxes of the macroprudential policy framework.

Instruments to counter the systemic threat of ecological imbalances

So what instruments can financial supervisors use to reduce the systemic risk of ecological imbalances? Of course, the first best option is for government to price these risks (e.g. carbon taxes, emission rights and caps). The earlier governments adopt climate policies, the better these risks can be contained.

Nevertheless, as these policies currently are not sufficiently implemented, systemic financial imbalances resulting from ecological pressures are allowed to build up and concentrate in certain financial institutions and markets, thus threatening financial stability.

Several financial market imperfections make that individual financial institutions are not willing or able to effectively reduce these risks. As potential systemic risks are left to build up, macroprudential authorities have a role to play.

The question then is how macroprudential policies can address ecological imbalances? We explore how macroprudential tools can be designed to curb specifically the carbon bubble and identify capital instruments (adjusting risk weights), caps, large exposure restrictions and stress tests as the most promising instruments (see Table 1. Illustrating this for the case of carbon emissions).

Table 1.:  Instruments for the Carbon Dimension of Macroprudential Policy

Panel A: Cyclical pillar


Intermediate target

Excessive credit growth for carbon intensive and dependent economic activities


Carbon intensity and dependency credit

Key instruments

Counter cyclical capital buffer

Capital instruments, higher risk weights for:

- carbon intensive and dependent sectors (transport, mining, energy)

- carbon intensive and dependent companies within these sectors

‘Carbon cap’

- exclusion list

- maximum debt finance for carbon intensive/ dependent sectors and companies


Panel B: Structural pillar


Intermediate target

Exposure concentration to carbon intensive and dependent assets

Misaligned incentives


Net exposure

Carbon intensity and dependency of SIFIs

Key instruments

Large exposures restrictions

SIFI capital surcharge


Conclusion and further research

Our study is a first exploration, one that suggests that environmental stress could be a relevant target for macroprudential supervisors. However, the problem is that currently there is a severe lack of data on the potential financial impact of, for instance, the ‘carbon bubble’, climate change, water and material shortages and other ecological factors.

It is therefore important to develop scenarios for the different sustainability challenges that provide estimates of losses and gains for different financial assets (equity and debt) over different economic sectors and the kind of companies within those sectors.

This further research can clarify which sustainability themes are the most important from a financial stability perspective. This may also help in deciding which of the here described macroprudential instruments are best suited for this challenge. Lastly, in order to stimulate learning and identify potential weaknesses in the supervision of the globally connected financial system, we propose that both the IMF’s FSAP[4] and the FSB[5]’s assessment of macroprudential policies take into account this ecological dimension.


[1] We use the broader term financial supervisor, which includes macro-prudential supervisors (often central banks) responsible for financial stability and micro-prudential supervisors responsible for individual financial institutions.

[3] KPMG (2012) converts twenty environmental impacts into financial value, drawing upon current environmental-economic research. They include greenhouse gases, water abstraction and waste generation. The physical totals of these inputs and outputs are converted into financial values and aggregated to achieve a total environmental cost value. The study is based on the operations of over eight hundred companies representing eleven sectors.

[4] The Financial Sector Assessment Program.

[5] Financial Stability Board.

Rens van Tilburg

Rens van Tilburg , par mmadeira

Rens van Tilburg est membre et directeur du laboratoire des finances durables à l’université d’Utrecht -

Rens van Tilburg is member and director of the Sustainable Finance Lab at Utrecht University -


Rens van Tilburg
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