In the crisis in Southeast Asia, which is the most spectacular example of such a financial crisis in recent memory, the real value of foreign currency loans often rose when domestic currencies depreciated sharply. This kind of dramatic event only occurs when asset prices rise higher than the levels justified by underlying economic factors. This kind of situation in an asset market is what is known as a bubble. It might be worthwhile at this point to stop and reflect for a moment on the fundamental relationship between monetary policy and asset markets, on the one hand, and product and commodity markets on the other. The purpose of explicit inflation targeting policy that has been introduced in Sweden and many other countries in the last decade is to address recurrent overheating in product and labour markets. It might be said - even if it is strictly speaking not quite correct - that the aim is to avoid the “bubbles” that tend to appear in these markets from time to time. Generally speaking, inflation targets have hitherto proved their worth in this respect, and inflation targets appear today to constitute a credible basis - a nominal anchor - for price and wage formation. However, no corresponding anchor exists in asset markets. This means that there is nothing to prevent the prices of various assets rising to levels higher than those justified by economic fundamentals owing to psychological factors, or “irrational exuberance” if you like.
Recently, a Task Force on Climate-related Financial Risks that operates under the Basel Committee on Banking Supervision looked into the effects of physical and transition risks on banks. This task force, which I have the honour to co-chair with the Federal Reserve System’s Kevin Stiroh, concluded that climate-related risks can be captured in risk categories that are already used by financial institutions and reflected in the Basel Framework, for example credit risk, market risk, liquidity risk and operational risk. This is a key insight which saves us from inventing all kinds of new risk categories. The existing ones will do. However, the task force also concluded that we still need an enhanced toolbox that can better measure climate risks. This is why the ECB is encouraging banks to enhance both the quantity and the quality of their climaterelated disclosures, and to become more transparent about their overall exposures to climaterelated risks. Banks are still in the early stages of incorporating climate change into their risk frameworks; risk identification and risk limits around climate-related goals do not yet actually feature in their risk management processes. This needs to change. Euro area banks need to drastically improve their capacity to manage climate-related and environmental risks and start acknowledging how these risks can drive others, including credit, market, operational and liquidity risks. Crucially, we have no need to await regulatory developments before formulating our expectations for the management of climate-related risks.