Carbon tax means losses for banks and insurance: MFSA

Banks, insurance companies and investment funds could face losses if a global tax on carbon is introduced, but would still be likely to recover quickly, a study from Malta’s financial regulator says.

Giorgia Conte and Francesco Meglio, analysts at the MFSA, sought out to study the short-term implications of a carbon tax on the investment portfolios of the Maltese financial system.

Overall, the study finds that a carbon tax would lead to limited losses because the nature of the investments made by most financial corporations can withstand its effect.

However, a few sectors could experience noteworthy losses, such investment funds, mostly non-domestic funds, that could suffer material losses. The study refers to two life insurance companies which could be influenced by the introduction of a moderate carbon tax rate.

The bottom line is that moderate climate policies such as a carbon tax could have minor consequences on the Maltese financial system. However, the study was only concerned with the investment portolio of financial corporations. Other assets such as corporations’ loan portfolios, could yield different results.

In fact, a stress-test carried out by the European Central Bank pointed out that Maltese banks are among the most exposed in the Eurozone to firms at high physical risk to climate change due to flooding or wildfire.

Climate risk affects banks through the loans they give out: when they lend money to firms, that firm could experience climate-related damage that renders them unable to pay back their loan. The risks are categorised into “transitional” and “physical” risks. Physical risk concerns tangible damage to a company’s property or capital as a direct result of climate-related catastrophe or disruption to the firm’s production chain; transition risks are all the risks arising from the transition to carbon neutrality such as rising carbon costs as governments penalise carbon use, and changing demand for goods that are more eco-friendly.

But research in this area is a challenge. There is a lack of reliable, consistent, and detailed data to help quantify climate change.

Another obstacle is the uncertainty that characterises climate change. No seasoned meteorologist can predict the weather patterns of five years’ time, rendering it a challenge to study long-term financial scenarios.

But studying shorter-term climate risks helps establish how resilient or vulnerable a company’s operations are to climate damage.

The MFSA researchers analysed six carbon tax policy scenarios and estimated the losses in equities, bonds, and holdings in collective investment schemes (CIS) to determine resilience.

Equities would incur the highest losses with the introduction of a carbon tax, followed by losses in collective investment schemes and bonds.

The main sources of transition risk for Maltese financial entities were found to be from manufacturers of non-metallic metal products, CIS, and suppliers of electricity, gas, steam, and air conditioning. These suppliers, together with suppliers of water, sewerage, waste management and remediation activities, presented larger-than-average losses.