Frequently asked questions on climate and the economy
The political authorities have the primary responsibility and the most effective policy instruments for reducing greenhouse gas (GHG) emissions. Nevertheless, both climate change and measures to reduce GHG emissions have an impact on the Norwegian and global economy. Thus, climate-related changes also influence Norges Bank’s mission, which is to promote economic stability and manage substantial assets on behalf of the nation.
Climate change and climate transition may affect the Norwegian economy in many ways. The effects may take the form of transitory shocks, for example related to weather conditions in Norway or abroad, and as more long-term, structural changes, for example related to climate transition. So far, Norges Bank has observed that climate-related factors have affected such key variables as energy prices and business investment.
Norges Bank sets its policy rate with the aim of stabilising inflation around 2 percent in the medium term. If a number of climate-related effects pass through to the economy over time, the policy rate may be affected, in the same way as for other shocks and structural changes in the economy. Furthermore, measures to reduce GHG emissions may affect the structure of the Norwegian economy. This may change the functioning of the economy, which in turn may have an impact on interest rate setting. The increasing frequency of extreme global weather events caused by climate change may affect the economy in a way that may make the trade-offs in interest rate setting more demanding.
In Norway, the primary monetary policy instrument is the policy rate, which is not an appropriate instrument to address climate change.
Climate change and the transition to a low-carbon society affect the economy and the financial system. In its financial stability analyses, Norges Bank is particularly concerned with the situation for banks. Climate risk may increase banks’ losses. Some banks will be more vulnerable than others, but in Norges Bank’s opinion, this increase in risk will be manageable. Moreover, proper credit analyses can help banks to reduce such risk. The Norwegian banking system is well-capitalised and should have the capacity to absorb potential losses resulting from increased climate risk.
In our opinion, the most important risk to the financial system is in bank lending to firms with high emissions or to firms that will experience a substantial rise in costs from a stricter climate policy. The importance of the oil and gas industry may amplify transition costs for the Norwegian economy. However, loans to oil producers account for a relatively small percentage of Norwegian bank loans, and banks are therefore less affected by higher costs and other restrictions affecting oil production.
Banks and insurance companies’ losses may also rise as weather patterns change. In Norway, a relatively large number of properties are located in areas exposed to landslides, avalanches, floods or spring tides, and this share could rise on account of climate change. Banks should take such risk into account in their assessments of new loans.
Forward-looking banks that actively assess climate risk should be in a good position to mitigate this risk on their current balance sheets. It is crucial that banks understand climate risk in lending practices. Losses may come as a surprise if climate risk is ignored or knowledge in the banking sector is insufficient. The longer banks wait to implement necessary measures to bring about the necessary changes, the stronger the measures may have to be later. A swift and abrupt transition may entail risks to financial stability. It is also important to point out that the full extent of the consequences of climate change is not yet apparent, which gives rise to heightened uncertainty.
Banks must also take into consideration that new investment opportunities resulting from climate-related changes may entail risk. Large-scale climate investment projects could in and of themselves give rise to investment cycles that increase the risk of financial crises.
It is important to establish routines for reporting GHG emissions, carbon costs and plans for transitioning to a low carbon economy to give banks the opportunity to assess climate risk in their portfolios. Improved assessments of the impact of climate change are also needed. Risk assessments have so far been related to specific events such as rising sea levels, high tides, river and coastal flooding, landslides and avalanches. Less research has been conducted on the indirect effects of climate change, such as changes to biological systems. It is therefore difficult to assess the risk exposure of the Norwegian business sector in this area. In the coming years, this risk must be addressed with the aid of scientific findings.
The role of Norges Bank is to monitor, analyse and highlight areas where the risk of financial instability may build up. In Financial Stability Report 2021, Norges Bank showed how climate risk in banks’ lending portfolios can be analysed. The analysis is at a general sectoral level. However, it is assumed that more data at firm level will be available in the years ahead and Norges Bank will work to improve the analyses. See Norwegian banks’ climate risk exposures for a further discussion.
Norges Bank Investment Management (NBIM) addresses climate change at market, portfolio and company levels. As an investor in 9,000 companies worldwide, it is important to identify how these three levels interact.
At market level, NBIM works to promote well-functioning, efficient and sustainable markets. In this regard, NBIM promotes common standards for sustainability reporting. At portfolio level, overall exposure is reviewed. Divestment, within the framework of the investment mandate, is considered for companies with particularly high sustainability risks. At company level, climate risk and climate-related opportunities are included in company assessments and in following them up. NBIM engages in dialogue, votes and follows up the boards of all the GPFG’s investee companies. In Norges Bank’s active management, investment opportunities can also be identified when they arise.
For more information on the GPFG’s work on climate risk, see Responsible investment (nbim.no)