With the transition to net zero, fossil fuel assets of banks and insurers will rapidly diminish in value or become entirely worthless. Massive losses will follow for financial institutions, which could result in them requiring bailouts, paid for by the public.

In the meantime, more frequent and severe natural disasters mean that insurance companies face huge claims, and financial institutions are exposed to financial losses through assets and business operations that are destroyed.

There is a solution.

A growing number of economists are proposing a simple solution to this impending crisis: implementing one-for-one capital requirements for fossil fuels. This is a form of financial regulation that means for each euro/dollar that finances fossil fuels, banks and insurers should have a euro/dollar of their own funds held liable for potential losses.

This basic risk management principle is already applied to other high risk exposures. For example, the Basel Committee just recommended the one-for-one be applied to some cryptocurrencies’ exposures.

Regulators must act immediately.

A one-for-one regulatory standard for financing new fossil fuels projects would mean that banks and insurance companies are gambling with their own money, and not the public’s money.

The current capital rules ignore the risk of financing fossil fuels, making fossil fuel exposures artificially more profitable – which equates to a subsidy. This is on top of the $1.54 million in direct subsidies and tax breaks the fossil fuel industry gets from governments every single minute.

Markets are notoriously bad at self-correcting, as we discovered in 2008. There are limited incentives to be the first mover on a voluntary basis. If one bank turned down a fossil fuel project, another one would swoop in and take its place – the project would still go ahead and the bank that did the right thing would lose out on any potential profits.

A one-for-one standard is the robust regulation needed to prevent unfair advantages for banks and insurers who continue to finance fossil fuels. It is a way to guide the market away from mutually assured destruction.