By Central Bank of Barbados
Do you feel like you’re in an oven when you go outside? Ever notice how much more often you hear about another storm, flood, or wildfire? These events are all caused by climate change, which has become one of the biggest issues for people, businesses, and countries as a whole. But did you know that climate change can also affect financial stability?
The 2023 Financial Stability Report, a joint document produced by the Central Bank of Barbados and the Financial Services Commission that assesses the soundness of Barbados’ financial system, says that climate change is one of the biggest risks to financial stability. But how can climate change affect financial stability? And why is this topic so important?
Defining climate change and financial stability
To answer those questions, it is first important to have a clear understanding of both:
Financial stability is when a country’s financial system – its banks, insurance companies, credit unions etc. – is stable and able to handle adverse situations without major disruptions, allowing consumers and investors to trust and have confidence in the system.
And according to the United Nations, “climate change refers to long-term shifts in temperatures and weather patterns.” Climate change can have many direct and indirect effects. Climate change drives the need for countries to adapt to and mitigate its impacts, which can lead to economic shifts and policy changes (transition risks), while the increasing frequency and severity of climate-related events pose direct threats to infrastructure and communities (physical risks). This year, the Central Bank of Barbados focused on assessing the impact of a climatic event and physical risk on the economy, and, more specifically, the financial sector.
How climate change can affect your financial situation
Now that we understand what both of them are, let’s look at the risks that climate change poses, and how those risks can affect financial stability.
Let’s use hurricanes, for example. If a hurricane were to hit Barbados, it could cause major destruction. Imagine that a farmer loses crops and livestock: How will he earn income? How will he pay his bills? Similarly, how will people be able to repay their loans if they have to fix their roofs, or replace their windows? If a business has to stop operating due to damage to buildings or loss of resources such as equipment and software access, how will it generate revenue? How will it continue to pay its employees, who depend on their salary to cover their own damages?
You might say that you could always rely on savings, a pay out from your insurance coverage, or that you could take out a loan. That’s true, but the coverage might not be available and savings might not be sufficient. Just as climate change can create significant challenges for you, it can do the same for financial institutions as well.
How climate change affects key financial institutions
The Financial Stability Report details the potential impact of climate change on deposit-taking institutions (DTIs) – commercial banks, credit unions, and deposit-taking finance companies. Considering that maintaining financial stability requires these financial institutions to absorb shocks, let’s take a closer look at the potential effect on them.
One of the biggest potential issues is non-performing loans (NPLs). These are loans where the borrower has not made payments for at least three months. In the event of a hurricane or any other climate-related incident that causes significant physical damage, particularly hotels located in coastal areas, this may impact the number of tourists that Barbados can accommodate. This could lead to job losses and a decrease in income for local businesses.
There is also likely to be a significant increase in households and businesses being unable to repay their debts. This could cause a problem for banks, credit unions, and finance companies because, although they set aside funds (known as provisions) for bad loans, and too many bad loans at the same time could result in losses that exceed their provisions. Additionally, these losses could cause them to provide fewer loans to households and businesses, thereby stunting economic growth and investment.
So, what have we learned?
Climate change isn’t just an environmental issue; it affects financial stability by causing income loss and property damage. It also poses significant risks to financial institutions, leading to rising non-performing loans and reduced profits. The Financial Stability Report delves deeper into these issues, offering valuable insights for business owners, finance professionals, and consumers. Whether you’re managing a company, working in finance, or just planning your finances, this report will be both beneficial and eye-opening.
Do you feel like you’re in an oven when you go outside? Ever notice how much more often you hear about another storm, flood, or wildfire? These events are all caused by climate change, which has become one of the biggest issues for people, businesses, and countries as a whole. But did you know that climate change can also affect financial stability?
The 2023 Financial Stability Report, a joint document produced by the Central Bank of Barbados and the Financial Services Commission that assesses the soundness of Barbados’ financial system, says that climate change is one of the biggest risks to financial stability. But how can climate change affect financial stability? And why is this topic so important?
Defining climate change and financial stability
To answer those questions, it is first important to have a clear understanding of both:
Financial stability is when a country’s financial system – its banks, insurance companies, credit unions etc. – is stable and able to handle adverse situations without major disruptions, allowing consumers and investors to trust and have confidence in the system.
And according to the United Nations, “climate change refers to long-term shifts in temperatures and weather patterns.” Climate change can have many direct and indirect effects. Climate change drives the need for countries to adapt to and mitigate its impacts, which can lead to economic shifts and policy changes (transition risks), while the increasing frequency and severity of climate-related events pose direct threats to infrastructure and communities (physical risks). This year, the Central Bank of Barbados focused on assessing the impact of a climatic event and physical risk on the economy, and, more specifically, the financial sector.
How climate change can affect your financial situation
Now that we understand what both of them are, let’s look at the risks that climate change poses, and how those risks can affect financial stability.
Let’s use hurricanes, for example. If a hurricane were to hit Barbados, it could cause major destruction. Imagine that a farmer loses crops and livestock: How will he earn income? How will he pay his bills? Similarly, how will people be able to repay their loans if they have to fix their roofs, or replace their windows? If a business has to stop operating due to damage to buildings or loss of resources such as equipment and software access, how will it generate revenue? How will it continue to pay its employees, who depend on their salary to cover their own damages?
You might say that you could always rely on savings, a pay out from your insurance coverage, or that you could take out a loan. That’s true, but the coverage might not be available and savings might not be sufficient. Just as climate change can create significant challenges for you, it can do the same for financial institutions as well.
How climate change affects key financial institutions
The Financial Stability Report details the potential impact of climate change on deposit-taking institutions (DTIs) – commercial banks, credit unions, and deposit-taking finance companies. Considering that maintaining financial stability requires these financial institutions to absorb shocks, let’s take a closer look at the potential effect on them.
One of the biggest potential issues is non-performing loans (NPLs). These are loans where the borrower has not made payments for at least three months. In the event of a hurricane or any other climate-related incident that causes significant physical damage, particularly hotels located in coastal areas, this may impact the number of tourists that Barbados can accommodate. This could lead to job losses and a decrease in income for local businesses.
There is also likely to be a significant increase in households and businesses being unable to repay their debts. This could cause a problem for banks, credit unions, and finance companies because, although they set aside funds (known as provisions) for bad loans, and too many bad loans at the same time could result in losses that exceed their provisions. Additionally, these losses could cause them to provide fewer loans to households and businesses, thereby stunting economic growth and investment.
So, what have we learned?
Climate change isn’t just an environmental issue; it affects financial stability by causing income loss and property damage. It also poses significant risks to financial institutions, leading to rising non-performing loans and reduced profits. The Financial Stability Report delves deeper into these issues, offering valuable insights for business owners, finance professionals, and consumers. Whether you’re managing a company, working in finance, or just planning your finances, this report will be both beneficial and eye-opening.
