A study has found that SA banks have an exposure of almost a trillion rand to sectors vulnerable to the global energy transition, and this could trigger policy proposals to cushion the blow to the financial system and heap pressure on fossil fuel-tied industries to adapt.
Titled Transition and Systemic Risk in the SA Banking Sector, and published on the Reserve Bank website, the research shows that the sector is sitting atop a R2.8-trillion corporate credit loan book, 35% of which is tied to industries at risk of being left behind in the global shift towards a low-carbon economy.
The energy and transport sectors account for the lion’s share of this exposure, as highlighted by the authors: Pierre Monnin, a research fellow at the Council on Economic Policies, a global think-tank; and Ayanda Sikhosana and Kerschyl Singh, both of them macroprudential economists at the Reserve Bank. These sectors fall under the umbrella of what they term “transition-sensitive economic sectors” (TSES).
The implications of the 60-page report are far-reaching. Policymakers and regulators may face mounting pressure to come up with proposals to mitigate the risk to the financial system as banks may have to write off billions of rand in loans to vulnerable sectors. Simultaneously, the study fuels the national conversation about the coal conundrum — phasing out coal without risking energy security — and whether the government should craft policies to incentivise electric vehicle manufacturing and purchases.
Ripple effects
“To our knowledge, the potential contagion and amplification effects of a transition shock in the SA financial system are underdocumented,” said the authors. Evidence suggested relatively contained shocks in the financial system could ripple through the whole economy with job losses, credit write-offs and share price falls reverberating beyond the initial impact, they said.
Some researchers have estimated that for every job lost in the coal mining sector, three others are lost elsewhere in the economy. Similarly, the motor sector’s shock is amplified by a factor of 1.7, underscoring the interconnectedness of the vehicle industry value chain, which includes suppliers, dealerships and after-sales services.
“The direct exposure ... is thus only a fraction of the final banking sector’s corporate loan exposure to transition risks, the authors said, suggesting that financial market players have not fully factored in the potential shocks related to the transition to a more sustainable economy.
“This situation is prone to substantial and rapid adjustments in financial market prices and is likely to be the case in SA,” they said.
Policy options
The researchers recommended that the current macroprudential toolkit — which requires lenders to have enough money set aside to absorb losses in a crisis and control excessive lending — can be adapted to address climate-related systemic risks.
“The macroprudential framework already includes instruments that could be deployed to address climate-related systemic risks,” the authors said. “However, climate-related systemic risks also have their own specificities. Addressing them thus requires central banks and supervisors to review their current implementation practices and, if needed, adjust them.”
According to the study, authorities such as the central bank’s Prudential Authority could adjust the existing structural and cyclical instruments to jack up financial institutions’ ability to absorb unexpected systemic losses from climate shocks and prevent the build-up of climate-related risks.
The macroprudential framework, which oversees the stability of the financial system, is at the right level to address these risks, the authors said. Regulators could push through policies to encourage lenders to support a low-carbon economy, they said. “This can be done by setting incentives for financial institutions to limit their impact on climate change and to support economic activities conducive to a low-carbon economy,” they said.
The study suggests that central banks should move away from relying on historical data and instead focus on forward-looking information to assess prospective losses from climate-related financial risks and to introduce new capital buffers.
“Our results offer only a rough initial assessment of systemic risk from the transition away from fossil fuels. Given its potential impact on financial stability in SA, it deserves more scrutiny and a better assessment,” the authors said.
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