It’s well known that the climate crisis threatens virtually all investments as floods, fires, droughts and storms become more intense and frequent. But less understood is the risk climate change poses to the stability of the country’s economy.
To protect their money and ours, banks need to change the way they do business. And that shift, experts say, should be led by a quiet but significant player in Canada’s financial system: the Bank of Canada.
The Bank of Canada is an arms-length, federal Crown-corporation responsible for monetary policy; it manages inflation and plays a supervisory role in the economy.
But even though climate change is already costing the economy dearly, the bank currently does not have a mandate for climate policy, Tiff Macklem, the bank’s governor, told the House of Commons finance committee in May.
“Our mandate is solely monetary policy, controlling inflation and trying to mitigate vulnerabilities in the financial system,” he said.
Experts say it's time to change that — starting with a rethink of how the Bank of Canada defines economic and financial welfare. If the federal government changed the bank’s mandate, it could be used to protect the financial system from energy transition risks by factoring climate risks into its decisions on interest rates and financial reserve requirements. It could also take other measures designed to turn off the taps for fossil fuel financing.
As it stands, the Bank of Canada is “[throwing] a wrench in the green transition,” said Peter Dietsch, a University of Victoria professor who recently testified at a House of Commons environment committee on the risks of climate change to the financial system. Those risks are why it's important the bank be used to tip the scales in favour of a green economy.
Dietsch said the Bank of Canada’s independence from the federal government may have made sense in previous years, but an increasingly fragile economy due to climate change is “becoming too important to ignore.” Better coordination required between the federal government and the central bank is crucial “so that the right hand of the government doesn't undermine what the left hand does.”
“Who gives the Bank of Canada the mandate? The government does. Who elects the government? We do,” he said. “We have to realize that these are political choices that we're making.”
Commercial banks still maintain a fossil fuel heavy investment strategy. The consequences of maintaining that strategy are potentially dire for both the environment and the economy itself: if fossil fuel projects become money losers as demand for oil and gas plummets, there is a very real risk banks won’t be paid back their loans, plunging Canada into a financial crisis on the scale of the 2008 global recession.
At a Senate banking committee meeting in May, Brussels-based Finance Watch chief economist Thierry Philipponnat put it in just those terms, calling it imperative that Canada start seriously tackling fossil fuel risks to the financial sector.
“If we don’t, it’s certain that, in human terms, we’ll have a new financial crisis on top of the climate crisis,” he said. “Exposure to fossil fuels is equivalent to the amount of subprime mortgages that triggered the crisis 12 or 14 years ago.”
The circumstances that built this dangerous fossil fuel bubble have been growing for years. Since the Paris Agreement was signed in late 2015, Canada’s big five banks (RBC, TD, Scotiabank, CIBC and BMO) have steered at least $1.2 trillion into coal, oil and gas companies through loans, investments and underwriting. And a recent analysis from the University of Toronto’s Toronto Climate Observatory found that in 2022, just 18 companies on Bay Street loaned or invested $1.4 trillion to fossil fuel companies, generating over a billion tonnes of greenhouse gas pollution.
Financial institutions’ support of the fossil fuel industry provides the cash needed to embark on massive expansion projects, like the LNG booms on the West Coast of Canada or in the Gulf Coast of the United States that push emission-reduction targets further out of reach. All of those assets worth billions of dollars today could become worthless in a rapid transition off fossil fuels.
That financing also comes as the International Energy Agency, a global authority on energy supply and demand, warns that if the world is to meet the Paris Agreement’s goal to hold global warming to 1.5C above pre-industrial levels, there can be no more fossil fuel expansion anywhere in the world.
Better understanding the risk is a policy priority across government and the financial sector, and there are a few initiatives already underway. They include a forthcoming sustainable finance framework to define which investments count as green and which do not, and plans to require financial institutions disclose climate-related risks.
At best, these options merely nibble around the edges. That’s why experts are now calling on the federal government to put the Bank of Canada to work.
Julie Segal, climate finance manager with Environmental Defence, told the House of Commons environment committee in September that without ambitious steps taken to protect the economy from climate change, billions of dollars could be lost by financial institutions.
She recommended policymakers implement Independent Sen. Rosa Galvez’s Climate Aligned Finance Act, which proposes a suit of new rules to align the country’s financial sector. At a high level, the bill would require financial institutions to recognize climate change as a “superseding interest” for a company’s board of directors, set targets in compliance with a global carbon budget, avoid conflicts of interest at the director level, respect Indigenous rights and a host of other steps.
“To ensure the effectiveness of policy and regulation, you need oversight on those, just like in any other policy,” she said. “That's why modernizing the mandates of financial regulators is such an important piece.”
Putting on blinders
The problem is a collision at the intersections of climate change, resource extraction and the financial system.
Normally, federal governments try to attract economic investment. Canada has put considerable energy into attracting green technologies like critical minerals, electric vehicles and battery plants. But so far there has been little effort placed on chasing money out of the oil and gas sector even though it is an essential step to address the climate crisis.
Redirecting financial flows worth hundreds of billions of dollars is easier said than done. If a bank believes it can be paid back on a loan in a few years, there is little financial incentive to turn the cash faucet off. It doesn’t matter to a bank that fossil fuel assets could become worthless in 10, 15 or 20 years if it expects to get its money back in five.
This dynamic puts blinders on the country’s financial system as climate change unfolds, preventing influential financial institutions from taking a longer view of the energy transition and allowing risks to grow, experts say.
The Bank of Canada is a lender of last resort when Canadian banks are in trouble, so could wield tremendous influence on how commercial banks like RBC, TD and others conduct business. If it’s accepted that climate change poses a serious threat to financial stability, Dietsch told Canada’s National Observer the bank should begin disincentivizing commercial lending to fossil fuel projects.
One way to do that would be to charge higher interest rates for commercial banks exposed to fossil fuels, imposing a cost in the present, rather than leaving it as a future risk that could be ignored.
Another way to make fossil fuel investments less attractive would be to require banks to keep more money in reserve with the central bank if their lending to fossil fuels crosses a certain threshold.
“You could say ‘Well, if they are exposed to fossil fuels, that is from a social perspective a riskier attitude, and therefore we want them to have higher reserve requirements,’” Dietsch said.
Dietsch called higher interest payments and reserve requirements “relatively small adjustments,” but said even bigger impacts could be achieved with more aggressive action.
One option is the Bank of Canada could no longer consider fossil fuel assets as collateral for the purpose of lending to the banks themselves, essentially reducing their capacity to get loans.
Another option could be setting quotas that cap the amount of fossil fuel lending a bank is allowed to do, and over time lower the quota to “turn off the financial tap” and guide the transition off oil and gas.
The toughest change Dietsch discussed involves limiting the bailouts commercial banks could receive from the Bank of Canada depending on how exposed they are to fossil fuels.
However, threatening to cut off a bank from receiving bailout cash if needed would be tricky given the tradeoffs with financial stability, making this a difficult choice for a central bank to make in a crisis Dietch said.
The Bank of Canada declined to wade into the possibilities, given its lack of mandate to take climate into account.
“The Bank has no responsibility for climate change, and we have no comment on the experts' positions or options,” a Bank of Canada spokesperson said, in response to Dietsch’s options.
However the bank is studying climate change in collaboration with the Office of the Superintendent of Financial Institutions, provincial regulators, and the financial sector to better understand the impacts on the economy. To date, it hasn’t assumed a leadership role in avoiding those risks.
According to a recent ranking of the central banks of G20 countries, compiled by U.K. based non-profit Positive Money, the Bank of Canada is stalling compared to its peers and has dropped from 10th to 14th place due to its failure to adopt green policies, a lack of action the study’s lead author Zack Livingston called “alarming.”
Out of 130 possible points reflecting action on research and advocacy, monetary policy, financial policy and leadership, the Bank of Canada scored 25. Perhaps more importantly, the Bank of Canada has zero “high-impact” initiatives, according to the non-profit.
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