Newswise — By assigning a value to the expense of carbon, the Government of Canada intends to restrain greenhouse gas (GHG) emissions, yet it entails augmented peril for financial lenders and borrowers with elevated carbon emissions.
In a unique study, scholars from the University of Waterloo examined the repercussions of Canada's carbon pricing system on the economy. The findings suggest that as carbon expenses increase, industries characterized by significant carbon emissions, such as mining and energy, face the highest probability of default. Approximately $256 billion worth of assets and nearly a quarter of the Canadian GDP are exposed to climate-related risks, according to the study.
The research reveals the profound ambiguity that the Canadian economy confronts, underscoring the importance for financial lenders and regulators to evaluate carbon emissions and carbon price scenarios when conducting credit risk assessments.
"Canadian banks have significant involvement in providing loans to clients in carbon-intensive sectors, and despite their public pledges to uphold global climate objectives, they have augmented lending to such companies by billions of dollars," stated Adeboye Oyegunle, a PhD candidate in the School of Environment, Enterprise and Development. "If we fail to take proactive measures, these investments may lead to escalating costs, higher default rates, and increased bad debt, particularly when considering the evolving market dynamics and new government regulations."
Utilizing Toronto Stock Exchange data from 2010 to 2020 as a sample, the scientists employed the Canadian Government's carbon price framework ranging from $0 to $170 to scrutinize factors for forecasting insolvency until 2030. Though the findings indicate that carbon-intensive borrowers and financial institutions face the highest vulnerability, the consequences could severely impact the overall economy and affordability in Canada. As businesses typically transfer heightened expenses to consumers, resulting in escalated prices, the financial situation of the typical Canadian will be further strained.
The scholars suggest that lenders should commence or persist in incorporating both an actual and an implicit carbon price in their evaluations of credit risks. By doing so, they can effectively evaluate credit risks associated with carbon emissions and establish suitable interest rates for loans. Furthermore, central banks and other regulators in the financial sector should initiate the integration of metrics that gauge the industry's susceptibility to credit risks arising from climate change. This step will enable a comprehensive assessment of climate-related risks to the financial sector.
"Introducing a carbon price is an initial measure, but it is not the final step towards accomplishing a smooth transition to a low-carbon economy while minimizing credit disruptions," remarked Olaf Weber, a professor at the School of Environment, Enterprise, and Development. "In Canada, it is imperative that we thoroughly examine the financial implications, create tools and indicators for assessing risks, and expedite the shift towards a low-carbon economy."
The study, Carbon Costs and Credit Risk in a Resource-Based Economy: Carbon Cost Impact on the Z-Score of Canadian TSX 260 Companies, appears in the Journal of Management and Sustainability.
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