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The world’s financial stability watchdog has warned that disasters caused by climate change are increasingly likely to trigger broader panic in financial markets.
The world breached 1.5C of warming above preindustrial levels for the first time last year, raising the prospect of more environmental disasters.
The Financial Stability Board said the financial damage of climate shocks such as floods, droughts, fires or storms could cause a broader pullback in lending and downturn in investor confidence.
“Banks could reduce lending, including for recovery to already vulnerable households and corporates,” the body, which brings together the world’s central bankers, ministers and regulators, said. “There could also be an abrupt, broad-based repricing of climate-physical risk, as the expectation of larger future losses are incorporated into current prices and impact sectors and jurisdictions not currently directly affected by disasters.”
The report comes amid broader concerns about the capacity of the insurance sector to cover losses associated with climate change following devastating fires in Los Angeles that are estimated to have caused tens of billions of dollars’ worth of damages.
The Californian crisis has put the spotlight on how some major companies have been pulling out of the state, leaving about 10 per cent of residences without home insurance and many others reliant on a non-profit insurer of last resort.
Leading reinsurance groups are also paring back their exposure to natural catastrophe risks, while US lender Wells Fargo believes insurance payouts for the Californian fires could reach $30bn.
The Basel-based FSB said its research also found climate change was making insurance less available and more expensive, while also risking higher property losses and wider market stress.
“There are indications that insurance premiums have been rising in certain vulnerable areas to reflect expected or realised increases in physical risks, with some insurers withdrawing from markets that are deemed too risky,” the FSB said.
Without specifically mentioning the California fires, the FSB warned that this kind of disaster could lead to higher losses for banks and other firms, triggering broader stresses in financial markets by pushing up government borrowing costs and causing cross-border spillovers.
Pointing out that 62 per cent of the global losses from natural disasters were uninsured in 2023, the FSB warned: “Risks that are opaque and not well-managed could create correlated shocks whose impact is magnified as they propagate through the system.”
Some US lawmakers, meanwhile, have warned the fires, which have destroyed more than 12,000 structures and killed at least 25 people, could cause a permanent increase in insurance costs and require more state support to fill gaps in coverage.
“The California fires may be the trigger for an accelerated collapse in insurance markets,” said Senator Sheldon Whitehouse, until recently chair of the senate budget committee.
“The industry is looking at an entirely new and unpredictable risk profile for homeowners’ insurance . . . driven by climate factors that are worsening. This isn’t a fiscal blip of some kind that you recover from,” he added.
Regulators around the world are worried about falling levels of insurance cover for natural catastrophes.
A group of EU authorities last month called for the bloc to create a taxpayer-backed reinsurance scheme to fill the growing gap in cover against climate change-related disasters, such as last year’s floods in the Spanish region of Valencia.
The FSB’s report provides “an analytical framework and toolkit” to help regulators assess climate-related vulnerabilities.
Sarah Breeden, deputy governor for financial stability at the Bank of England, who chaired the FSB group that produced its new framework, said it “provides a forward-looking approach to be able to capture the unique aspects of climate risks while staying rooted in traditional financial stability analysis”.
Nellie Liang, under-secretary for domestic finance at the US Treasury department who also worked on the report, called it “a welcome addition” to financial markets surveillance.
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