Carbon price could pose $256bn credit risk for Canada's economy

University of Waterloo researchers have analysed the effects of Canada’s carbon price regime on the economy. Their findings indicated that, as carbon costs rise, high-emitting carbon industries could be placed at risk of default, facing a financial risk of $256bn (£203bn).

The study called on financial lenders to consider carbon emissions a part of their credit assessment of Canadian companies. 

Over the past few years, Canada has established a national minimum tax on carbon pollution above a certain sector-specific threshold, with the goal of transitioning to a net-zero economy. The price of carbon started at $20 per tonne in 2019, increasing to $50 in 2022.

However, the University of Waterloo study has exposed the uncertainty the Canadian economy faces as a result of these measures. 

“Canadian banks are deeply involved in lending to carbon-intensive clients and have increased lending to those companies by billions of dollars despite their public commitments to support global climate goals,” said Adeboye Oyegunle, PhD candidate in the School of Environment, Enterprise and Development.

“If we are not proactive, these investments could create increased costs, default rates and bad debt when you put these investments into context of the changing market and new government regulations.”

Using Toronto Stock Exchange data between 2010 and 2020 as a sample, the researchers applied the Canadian Government’s carbon price regime analyse variables for predicting bankruptcy until 2030.

While the results show that high-emitting carbon borrowers and banks are at the most significant risk, their loss could gravely affect the rest of the economy. 

In order to address this challenge, the researchers called on lenders to include a real and a shadow carbon price in their credit risk assessments. This practice will enable them to analyse carbon-related credit risks accurately and set an appropriate interest rate for loans.

In addition, central banks and other financial sector supervisors could start introducing indicators that measure the financial sector’s exposure to climate-related credit risks.

“Implementing a carbon price is a first step, but not the last one if we are to achieve an orderly transition to a low-carbon economy with minimal disruption to credit,” said Olaf Weber, professor in the School of Environment, Enterprise and Development. “For Canada, we must analyze the financial consequences, develop risk assessment tools and indicators, and accelerate the transition to a low carbon economy.” 

The study was published in the Journal of Management and Sustainability.