On 15 May 2024, the Governor of the Central Bank of Ireland (“Central Bank”), Gabrial Makhlouf gave a speech at the Annual Conference of the Environmental Protection Agency (“EPA”) entitled “Climate change: adapting to avoid the prisoner’s emissions dilemma”. Governor Makhlouf stressed that climate change is affecting both the economy and the capacity of central banks to meet their objectives of maintaining price and financial stability. In addition, he noted that climate change was one of the three significant economic transitions that are happening, alongside digitalisation and demography. While Governor Makhlouf identified the significant risks of climate change, he also acknowledged the potential for economic benefits for Ireland and noted that in the last decade €65billlion has left Ireland via energy imports, and that by 2050, Ireland will have the potential to be a major renewable electricity exporter.
Key Risks to the financial system
Governor Makhlouf noted that a major event such as flooding can have significant impacts across multiple sectors, such as insurance coverage, loan repayments, and the impact on loans secured by collateral that has been impacted. The transitional risks of decarbonisation will also have a negative effect on business costs and revenue. He noted that these risks will not be evenly spread and that while highly intensive sectors will need to make dramatic changes to their business models, there will also be winners, such as those offering lower emission products.
Adaption to the real economy
Governor Makhlouf stated that “Ireland will have more frequent and severe flood events over the coming decades”. As a result of this, properties may end up becoming uninsurable, which may have a knock on effect on the risk levels of mortgages. He noted that there was already evidence that such factors were being considered by lenders, and overseas examples of lenders withdrawing from granting mortgages from properties with high flooding risks.
Governor Makhlouf also acknowledged that many of the impacts from damage are alleviated by insurers who play a vital role in providing security for people and businesses. However, the insurance market is also facing challenges and more severe, and significant climate events will lead to higher premiums and lower insurance coverage in higher risk areas. In addition, as climate risks are increasing across the world, the diversification of country level risks via the reinsurance market is becoming more expensive and restrictive.
Opportunities for insurers still exist, and learnings from international policy innovations may help to prevent pressure on underwriting where defences are not economically or technically feasible. Governor Makhlouf noted that by reducing risk through adaption, insurers can retain a risk-based pricing approach, and potentially expand risk appetite and offers of insurance. Collaboration between the public and private sectors may also help to enable insurers to retain a risk-based approach to pricing.
Adaption to the financial sector
The financial sector must also adapt by embedding climate risks into its models, systems and policies, and to consider risk over longer time periods. Governor Makhlouf stated that “we appear to be in the midst of a climate risk transparency revolution”. He noted that investment flows follow both profitability expectations and climate risks in terms of decarbonisation costs, and the likeliness of physical damage. Disclosure requirements have also increased the flow of climate data sources, which alongside stronger government policies and target commitments, will help to align investment flows with transition goals.
Governor Makhlouf also noted that the policy mechanisms contained in the existing prudential framework must be adapted to include climate risks. He stressed that it was too soon for a “wholesale recalibration of the capital framework”. However, as data availability and risk forecasting continues to improve at pace, the Central Bank may act where risks are clear, large and quantifiable.