Who pays when it comes to climate adaptation is a distribution issue, according to the Reserve Bank

The Reserve Bank (RBNZ) told Parliament's Finance and Expenditure Committee banking has a “key role” to play when it comes to climate adaptation.

RBNZ Assistant Governor Simone Robbers and Strategic Climate Initiatives Manager Stefan Grey appeared at the Government’s ongoing climate inquiry on Monday to discuss their submission. Robbers is also the central bank’s General Manager of Strategy, Governance and Sustainability.

The FEC was given the responsibility of determining how NZ manages the risks and expenses associated with future extreme weather events back in May.

The inquiry plans to provide recommendations and principles on a climate adaptation framework and report back to Climate Change Minister Simon Watts on the 5th September.

Robbers told the FEC the RBNZ had three core objectives: price stability, financial stability and acting as a central bank. Climate change presents risks across those areas if left unmanaged through both adaptation and mitigation strategy.

“The financial system itself has a key role to play in adaptation through funding or intermediating funding for mitigation and adaptation activity, as well as providing price signals through pricing risk, for example insurance premiums or risk premiums on lending,” she said.

“So we take the impact of climate change seriously.”

Robbers said the RBNZ had been working with the financial sector and regulatory counterparts, both in New Zealand and overseas, on how to manage and adapt when it came to climate risks.

“Our work has highlighted the financial, economic and social importance and urgency in developing a comprehensive and enduring adaptation framework,” she told the FEC.

Too little, too late

In 2023, the RBNZ announced it was undertaking a climate stress test on NZ’s major banks. BNZ, ASB, Kiwibank, ANZ NZ and Westpac NZ participated in the test. These five banks make up 90% of NZ’s banking.

A report was released in April this year.

The Climate Test Scenario (CST) which was called Too Little, Too Late combined high physical risks from climate change with high transition risks from global and domestic decarbonisation efforts.

The CST, designed to be potentially stressful with “severe yet plausible” scenarios, extended the test timeline from the usual three to five years to 2023–2050. This longer period reflected the long-term nature of climate-related risks.

“The extended timeline posed one of the biggest challenges for developing the scenario and for banks modeling the impacts,” the central bank said in its April CST report.

The RBNZ said banks’ modeling showed that climate-related risks could significantly reduce profits and dividends while increasing risk-weighted assets over the medium to long term, impacting the system’s resilience. 

Although banks maintained solvency in the CST, shareholder returns suffered, with modeled dividends coming in at nearly 40% lower and profits 25% lower than a base case scenario without climate risks.

“Aggregate impairment expenses were five times that of base case. The financial impacts are less acute but more drawn out than previous solvency stress tests, underlining the long-term, cumulative nature of climate-related risks,” the report said.

A distribution issue

Robbers told Monday’s Select Committee that who pays for a climate adaptation is a distribution issue.

“This is appropriately a matter for Parliament, but we caution if left solely to the market, costs are likely to fall disproportionately on those least able to afford it, small business, individuals and communities, resulting in wider wellbeing issues,” she said.

Robbers added that there was a “challenging balance” to be made between equity and incentivising appropriate risk management through market mechanisms. 

“International experience today indicates that clear funding and policy commitments from government are necessary to attract the substantial flows of private capital required to finance the adaptation,” she said.

She said banks and insurers are working together to improve climate risk management by using comprehensive data, but the current data on climate risk is “patchy.”

FEC Chairman Stuart Smith told Robbers and Grey that insurance companies had been clear with the Committee that they weren’t planning to withdraw coverage, but risks will likely be reflected in higher prices.

“However their job is to price risk and no doubt the risk will be reflected in the price,” he said. 

He asked the pair if NZ should be considering types of insurance like parametric insurance for climate events similar to those of the Auckland floods and Cyclone Gabrielle.

Parametric insurance is a type of insurance that pays out a set amount based on the occurrence of a specific event – rather than the extent of the damage.

Grey said there had been a lot of international experience where parametric insurance was a useful and reasonable solution and there was already a “small bit of experimentation” going on in that area.

“It’s definitely a possibility,” he said. (See more on parametric insurance here).

Parliament was warned last week that the increasing frequency of major natural hazard events is causing global reinsurers to reassess New Zealand's risk profile.