Prudential Regulations for Greening the Financial System: Coping with Climate Disasters

Prudential Financial Regulators, Central Banks and Regulatory Authorities have increasingly come to recognize that they have a role to play in dealing with climate change, including climate disasters such as storms, tornadoes and tsunamis. Such events impact the economy by destroying physical assets, income opportunities, credit worthiness and the fiscal base. In turn, the financial system is impacted by destruction of collateral and of ability to pay, an increase in defaults, required insurance payouts and a flip in the fiscal balance.

A working paper by Daniel M. Schydlowsky examines the present ways in which prudential regulation can be recruited to improve how societies deal with climate disasters, explaining that policymakers and financial prudential regulators have a duty to improve how they handle the growing climate challenge. 

The article provides an overview of regulators’ policy options, falling into four categories: those that provide direct support, those that promote supporting responses by the system, those that protect from the effects and those that prevent the consequences as much as possible. Regulators also have a role to play in turning prospective climate disasters to advantage, by inducing assets to become more resistant in the face of climate change and by supporting technological and behavioral change. Fortunately, the specific regulations required are well within the familiar toolkit of the regulators. The author ultimately argues that a quick response to this newly recognized challenge is fully feasible.