Let’s insulate financial stability from climate disasters

Any global fund requires an agreed pattern of funding. Lack of cooperation starts right there. The US, even under Joe Biden’s presidency, wants contributions to be voluntary. Mandated contributions with the US as a lone dissenter might be possible, but unlikely. Developed nations are not feeling either rich or generous right now. The US is in a fiscal crisis on account of its counter-covid expansionary fiscal policy, aggravated by arms support for Ukraine. The US could see possible closure of government offices in January if its public debt limit provisionally lifted in June this year is not legislatively sanctioned by then. The UK has careened towards public debt exceeding 100% of GDP, after having narrowly staved off strikes by public service employees with a modest pay increase, while at the same time protecting political supporters of the ruling Conservative Party from tax increases. France has faced down an extended protest against tightening of its pension rules.

Even if the Loss and Damage Fund is hammered through with some combination of mandated and voluntary contributions, there is the issue of how it will be disbursed. Within India, Finance Commissions resolve a similar problem with respect to disaster funding for states from the Central government, by splitting it into two parts. One part bases state entitlements on their historical pattern of expenditure on natural disasters (now modified by some parametric benchmarking and a disaster risk index). The other part is a supplementary national fund disbursed case-by-case for outlier events.

There is no historical pattern for the global Loss and Damage Fund to go by, since it is intended entirely for events unprecedented in incidence and ferocity.

As for disbursement, how is the fund to decide between full cover and fractional cover for tornados, floods, crop-scorching temperatures, forest fires and so on?

Until the Loss and Damage Fund is sorted out, climate disaster risk remains uncovered by global funding. The task of protecting financial stability in the midst of these random hits falls to the lot of central banks. People associate central banks with responsibility for price stability, but in a speech at the recent Kautilya Conclave in Delhi, Reserve Bank of India Governor Shaktikanta Das carefully etched the distinction between price stability and financial stability. The one by no means subsumes the other.

There does of course exist a private insurance market for risk cover, which is then shared with global reinsurance companies; so in that sense climate risk does get spread over a worldwide pool. However, rising climate risk, even if climate events are not synchronous, will see rising premia. Already, there is reported to be a planned hike of up to 25% in the insurance premium for infrastructure facilities in India scheduled to come into operation from December. This premium hike was triggered by a glacier melt in Sikkim and the huge insurance claim by Sikkim Urja, an electricity utility, for damage sustained in that calamity. The premium hike is said to have been demanded by global reinsurers that took on part of the risk from primary insurance companies. A massive premium hike for all infrastructure insurance in India, given the variation in climate risk across geographies in such a large country, looks like unjustified contagion.

Insurance cover notwithstanding, jagged responses like this to climate events can pose dangers for financial stability. The premium hike will raise costs for infrastructure installations. That, together with disputed and delayed honouring of insurance claims, carries ill portents for commercial banks with large exposures to infrastructure lending.

The extreme climate events that affected crops worldwide, from the excessive pre-monsoon rain that squashed India’s tomato crop, to the lack of rain in Spain which withered its olive crop, will likewise raise crop insurance premia as we go forward. In all these cases, the premium hike will come after rather than before the disaster, and therefore will not pre-empt knock-on effects on the stability of the banking system. Central banks face the unenviable task of maintaining financial stability through all these upheavals.

While global funds may not take shape any time soon, there is scattered evidence of small funding targeted towards particular uses. There is a recent US offer to extend $150 million to India as financial support towards the replacement of diesel-powered public bus fleets with electric vehicles (EVs), to help achieve national climate commitments. Looking past whether that policy is altogether wise, the fund is intended to provide payment guarantees to suppliers of EVs, given the poor financial health of public transport companies. For now, this is the kind of small-scale bilateral assistance that may be forthcoming.

Deeper into the transition, government time-tables for the phase-out of fossil fuels will have to be closely coordinated with directions to the banking sector for approved directions of financing.