Inflation exceptions is a curve ball ahead of Canada’s economy: Economist
Canada's financial sector could be exposed to significant economic shocks from the transition to lower emissions according to early scenario modelling from the Bank of Canada and the banking regulator.
The pilot study isn't meant as a forecast but considers several climate policy scenarios and how they could play out across the Canadian economy. The scenario work, however, does emphasize the immense transitions underway, said Toni Gravelle, deputy governor of the Bank of Canada.
"All scenarios showed that as we globally transition to net zero, some sectors will be significantly impacted, and the economy as a whole will undergo significant structural changes."
Speaking at a media briefing, Gravelle said that the study shows that Canada's banking and insurance industries need to plan carefully for the transition underway.
"For the financial sector, mispricing these climate risks could expose financial institutions and investors to sudden and large losses."
The Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI) say the initiative is an early attempt to better understand the long-term risks posed by the transition away from greenhouse gas emissions, and to assess how well banks and other financial institutions are themselves modelling the risk.
Gravelle said it's clear that both financial institutions and financial authorities are in the early stages of building capacity to better understand the risks and transitions ahead.
Ben Gully, assistant superintendent at OSFI, said that while many institutions are just starting to ramp up efforts, there's still time as the regulator aims to establish resiliency by the end of the decade.
"We have some time, but no time to waste in preparing for 2030."
The report says that Canada is at higher risk of economic impacts from the transition because of significant exposure to commodities that will see price declines as climate policies such as carbon pricing strengthen globally.
The scenarios show that faster action on climate change will lead to a smoother, less risky transition, while modelling for especially abrupt global policy changes showed potential financial-market disorder as Canada's GDP falls 10 per cent lower than where it would be by 2050 compared with the baseline scenario.
The pilot study found that fossil fuel sectors are particularly exposed to risk, though others including crop and livestock sectors would also take a hit, and the electricity sector would get a boost.
One scenario, which looked at moving immediately toward the policies needed to keep warming to two degrees Celsius, found that refined oil producers would see by 2050 a 72 per cent drop in net income and a 450 per cent increase in the possibility of default compared with the baseline, while the crop sector could see a 32 per cent drop and a 141 per cent increase in potential default.
The scenarios, looking at a 30-year timeline, make numerous assumptions and also didn't factor in several key factors such as the physical risks of climate change and how some new technological innovations could change the trajectories.
The report, which was produced in collaboration six financial institutions, found that modelling can take more effort than expected, and is still hampered by spotty access to data.
Gully said that while an early effort, the pilot was a success as it raises awareness of the risks and works towards better understanding the implications.
"Climate scenario exercises like this one make clear the potential impacts of transition risk across a range of different climate pathways."