🌍 The Impact of Carbon Pricing on Credit Risk: Insights for Financial Institutions and Regulators 📊💼
A recent study by Oyegunle & al. has interesting findings on the effect of high greenhouse gas (GHG) emissions on the credit risk of companies. The study specifically examines the potential impact of carbon pricing policies on credit risk and offers valuable insights for financial institutions and regulators.
Key Takeaways:
🔸 Introducing carbon pricing could significantly increase the credit risk, measured by Altman’s z-score, for Canadian companies, particularly those in high-emitting industries such as materials and energy. This finding underscores the potential rise in default risk for banks with lending portfolios exposed to these industries.
🔹 High-emitting industries already exhibit higher credit risk compared to other sectors, indicating their susceptibility to climate change related factors.
🔸 Financial institutions in countries with a substantial presence of high-emitting industries face elevated financial risks compared to economies with lower-emitting sectors, as carbon pricing exerts a more significant influence on these industries.
🔹 Incorporating carbon emissions and carbon price scenarios into credit risk assessment processes is crucial, as multiple studies have demonstrated an increase in credit risk for companies with poor sustainability performance.
Implications:
💡 Central Banks and financial sector supervisors should introduce indicators that measure the financial sector’s exposure to climate-related credit risks, given the increasing likelihood of carbon pricing in many countries. Utilizing carbon pricing scenarios proposed by the Task Force on Climate-related Financial Disclosures can aid in analyzing portfolio climate risks.
💡 Financial institutions should consider integrating both real and shadow carbon prices into their credit risk assessments to accurately evaluate carbon-related credit risks. Implementing an internal carbon price on credit can serve as a meaningful starting point for institutions’ climate mitigation efforts.
💡 Improving GHG emissions reporting and disclosure is crucial for enhancing the quality of data used in such analyses. Encouraging firms to disclose emissions data, particularly for Scope 2 and Scope 3 emissions, will provide more accurate information for evaluating credit risk.
By incorporating carbon-related factors into credit risk assessments, lenders can effectively analyze risks and establish appropriate interest rates, while supervisors can develop strategies to mitigate climate-related credit risks.
📚 Reference: Oyegunle, A., Weber, O., & Elalfy, A. (2023). Carbon Costs and Credit Risk in a Resource-Based Economy: Carbon Cost Impact on the Z-Score of Canadian TSX 260 Companies. Journal of Management and Sustainability, 13(1), p187.
