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Original article: https://theconversation.com/climate-shocks-and-the-economy-we-asked-south-africas-central-bank-what-role-it-plays-in-bringing-stability-239328
Climate change poses economic and social risks which can affect the workings of the financial system – the complex interaction of financial institutions and markets. Central banks, as the custodians of stable financial systems and stable prices (low, stable and predictable inflation), have a responsibility to ensure that financial systems can survive and manage climate-related shocks.
South African Reserve Bank, Author provided (no reuse)
The South African Reserve Bank approaches this in three ways. It aims to ensure that financial institutions and markets consider climate-related risks in their operations. It seeks to understand the effects of climate change on inflation and financial stability, and take action against these risks. And it is greening its own operations. To tease out these issues, Danny Bradlow posed questions to Fundi Tshazibana, deputy governor of the South African Reserve Bank, CEO of the financial sector regulator, the Prudential Authority, and vice-chair of the Network for Greening of the Financial System.
Is environmental sustainability part of the Reserve Bank’s primary responsibilities?
Sustainable economic growth implies that an economy is growing continuously at its potential and avoiding boom and bust episodes. It also implies that nature’s resources are being used sustainably in the process. Different public economic institutions are equipped with tools to manage the various aspects of sustainable growth.
The South African Reserve Bank’s constitutional mandate suggests that the central bank’s role in ensuring environmental sustainability is indirect as protecting the value of the currency does not have a direct impact on carbon emissions or the environment.
But stable macroeconomic conditions create an enabling environment for investment into environmental sustainability. In addition, environmental factors and climate-related risks have price effects. They directly affect the cost of agricultural production and fossil fuels.
Climate-related events also have the potential to drive up insurance premiums. These price effects have implications for inflation and thus the price stability mandate of the Reserve Bank.
Does the South African Reserve Bank have a mission statement that spells out climate-related responsibilities?
Climate change and other factors with the potential to induce major economic shifts, such as artificial intelligence, are implicitly part of the Reserve Bank’s mission statement as they affect price and financial stability. The current mission statement incorporates the Reserve Bank’s objective to tackle all risks to price and financial stability, including climate change.
Some people maintain that climate change affects all aspects of the economy so profoundly that central banks’ credibility will be undermined if they do not incorporate climate change into their work. What is your view?
Climate policy is not the responsibility of South African Reserve Bank. However, a central bank cannot ignore the impact of climate-related risks on the economy.
The bank’s mandate is price and financial stability. It has the tools to identify, analyse and manage price and financial stability risks in the economy. This includes those that are linked to climate change.
Analytical work on weather – and climate-related risks – is not new to the South African Reserve Bank. South Africa is in a region that is prone to drought, which at times has significantly affected food prices. Given the share of food prices in the overall inflation basket, these periods have been marked by elevated levels of inflation.
Climate-related risks have also materialised through the prevalence of wild fires, flood damage and other natural disasters. The volume of insurance claims associated with these events has forced the bank to evaluate their impact on the stability of the insurance sector and financial system as a whole.
If central banks were to have a more explicit role in tackling climate change, they would need to be given the tools to do so. However, it is important to recognise that different government departments already have many of these tools in their respective arsenals. For example, the transition to cleaner energy sources stands to reduce the output of certain mining activities. This will have negative effects on nearby mining communities as businesses and individuals lose income. The Department of Mineral and Petroleum Resources, as well as the social development, labour and education ministries, will have to consider these. And ways to address them.
We also need to understand the macroeconomic implications of the green transition. This includes employment opportunities created by new industries. Doing so requires coordinating our efforts and using our different tools effectively. This is not a job for one institution.
Do you think central banks should conduct climate impact assessments of their policies?
All public institutions should be conducting impact assessments of their proposed policies. These ought to consider climate change and the environment where appropriate. The South African Reserve Bank undertakes substantial analytical work. It has published several papers that analyse the implications of climate change on monetary and financial sector policy.
The bank conducted the first major stress test of South Africa’s major insurance companies in 2023/24. This included a climate change component. Climate risk will increasingly feature as a component of the bank’s stress-testing scenarios.
Climate-related risks were also discussed with 22 financial institutions regulated by the Prudential Authority in 2023. This resulted in a detailed Climate Risk Practices Observation Report.
In addition, the Prudential Authority issued four guidance notes on climate-related disclosures for public consultation. These covered risk management and governance practices for banks and insurers.
This is part of the Prudential Authority’s work to help institutions integrate climate-related risk into their business practices, strategies and management as well as to disclose these risks. The authority will monitor these.
Some central banks are greening their approaches to the assets they buy. What is the South African Reserve Bank’s view?
There are no restrictions on purchasing environmental, social and governance bonds, provided these investments fall within the bank’s approved Reserves Management Investment Guidelines.
Recently, the bank invested a small portion of its foreign exchange reserves into a green bond fund. Like many other central banks, it continually assesses these approaches and their suitability for our market conditions.
South Africa’s environmental, social and governance bond market is still in its infancy. More issuance by the public and private sectors will broaden the set of investors, creating a more liquid and transparent market.