The Swiss National Bank Struggles to Manage Climate Risks

This article was originally published in French by l’AGEFI.

 

The Swiss National Bank (SNB) will announce record losses for 2022. This result is not a problem in itself: the SNB’s mandate is not to generate profits and this year’s losses are of no consequence to its ability to control inflation. However, the amounts involved are a good reminder of the financial risks to which the SNB is exposed.

Controlling risks to keep them low on its balance sheet is a fundamental task of any central bank. This includes the significant financial risks associated with climate change. Central banks are well aware of this.

In Europe and elsewhere, they are implementing measures to contain these risks in their asset portfolios. The SNB is not among the leaders in this area. It would benefit from emulating the practices adopted by the institutions at the forefront of climate risk management, to better control these risks in its own reserves.

Risk management is essential for the SNB

A certain amount of risk-taking is perfectly normal for the SNB. It is a natural consequence of the implementation of its monetary policy and the measures it takes to ensure the stability of the financial system. To accomplish this task, however, it is unanimously recommended that central banks adopt prudent financial risk management and control the level of risk in their portfolios. Contained and limited risk helps central banks to mobilise the necessary resources in the event of a financial crisis and to preserve the value of their reserves, which enhances their credibility.

Central banks generally comply with this requirement. It is common practice for them to accept only the safest financial securities for their monetary transactions. The SNB is no exception to this rule. For its equity portfolio, for example, the SNB has opted for a different allocation than the one observed in stock markets. It invests relatively less in the securities of small and medium-sized companies than of large ones, to reduce the higher risk generally associated with this type of company.

Climate-related financial risks need to be appropriately managed

In recent years, central banks have paid particular attention to the financial risks associated with climate change. For a good reason: these risks are material and widespread on the balance sheets of financial institutions, including central banks. Moreover, they will materialise in one way or another over the next few years.

Financial institutions are lagging in terms of climate-related financial risk management. Most European institutions, for example, have been repeatedly warned by supervisory authorities about their inadequate management of these risks. The exceptions, those at the forefront of climate risk management, attach only limited importance to the evaluations observed on markets. They prefer to implement strategies based on forward-looking information, which is better able to anticipate risks from climate events that have yet to be observed on a large scale.

The SNB is behind the curve

Central banks are aware of the challenges that climate-related financial risks pose for their balance sheet risk management. They have begun to adapt their practices in this area. Since last year, for example, the European Central Bank (ECB) has been reducing its share of bonds issued by corporates with poor climate performance to mitigate these risks on its balance sheet. The Monetary Authority of Singapore (MAS) has also changed the investment policy of its foreign exchange reserves to reduce its exposure to climate risks.

Unfortunately, the SNB is not yet at this stage. For its equity portfolio – a quarter of its currency reserves – the SNB does not include any climate risk indicators in its investment strategy. This method is not in line with those adopted by leading financial institutions in this area. It is therefore likely to expose the SNB to more risks than would be justified by a conservative and prudent long-term risk management strategy.

The SNB would benefit from emulating the practices of leading institutions in this area and adopting a management approach based in part on forward-looking climate risk indicators. This would reduce its overall exposure to financial risks and enhance the soundness of its reserves.