Climate change introduces a line of financial risks that complicate the operating environment for banks and deposit insurers. Physical risks, such as extreme weather events, directly impact asset values and operational continuity. Transition risks, stemming from the global shift toward a low-carbon economy, can lead to significant asset revaluation, particularly in carbon-intensive sectors. Additionally, the uncertainty and inconsistency of global political and policy commitments to climate action make climate-based insurance for the financial sector highly complicated. These risks heighten the likelihood of bank failures.
With this, the urgency to fortify deposit-insurance frameworks becomes increasingly evident. Enhancing reserves and ensuring sufficient capital buffers of deposit insurers are necessary to manage claims arising from climate-induced financial distress. India has been a shining example of being an active participant with all of its banks covered under deposit-insurance regulatorily. Hopefully, in next few years, a bank portfolio’s climate-resilience report could determine its annual deposit-insurance premium.
Digital innovation offers transformative potential for deposit-insurance, providing both benefits and challenges. Technologies such as blockchain can provide secure, transparent, and immutable records, reducing fraud and operational risk. However, rapid pace of technological change can outstrip regulatory frameworks, creating vulnerabilities. Cybersecurity risks, data privacy concerns, and the potential for systemic risks from fintech and digital banking platforms necessitate robust regulatory supervision and adaptive policy frameworks.
Blockchain technology
Tokenised deposits, representing the digitisation of traditional deposits using blockchain technology, present unique challenges and opportunities. Tokenisation can enhance liquidity, transparency, and the efficiency of financial transactions. However, insuring tokenised deposits requires rigorous risk assessment frameworks that account for the technological and operational risks inherent in digital assets. Ensuring fund protection in a decentralised environment demands innovative approaches to custodianship and insurance coverage. Regulatory considerations must evolve to address these new forms of deposits, ensuring that protections are in place to safeguard depositors and maintain financial stability.
Climate change-related financial risks necessitate a proactive and dynamic approach from deposit insurers to strengthen crisis preparedness and management. This includes integrating climate risk into core regulatory frameworks, enhancing stress testing protocols, and fostering greater transparency in climate risk disclosures. Deposit insurers must work closely with financial institutions to develop robust risk management strategies that address the impacts of climate change. Scenario analysis, climate risk modelling, and the development of climate-resilient financial products are critical components of this strategy.
Establishing robust contingency plans, including predefined emergency response protocols and cross-border cooperation agreements, is crucial for enhancing the ability to respond swiftly and effectively to crises. These measures ensure that deposit insurers are prepared for sudden and unexpected disruptions, allowing for coordinated and timely interventions to maintain financial stability. Cross-border cooperation agreements facilitate the sharing of information and resources among international financial institutions, enabling a unified approach to managing systemic risks that can transcend national boundaries. Such collaboration is particularly important in an increasingly interconnected global financial system, where the failure of a significant institution in one country can have ripple effects worldwide.
There is a need for deposit insurers to be involved in central banks’ real-time discussions with their REs (regulated entities), instead of being a back-office input. Furthermore, deposit insurers should prioritise international cooperation and knowledge sharing to address the global nature of climate risks. Collaborative efforts can facilitate the exchange of best practices, harmonise regulatory approaches, and foster sandbox regulations across global financial markets rather than just domestic sandbox approach.
The writer is policy researcher and corporate advisor