Greening the Financial System: Tilting the playing field - The role of central banks: New Climate Bonds Report

Measures to address systemic climate risks & aid shift in capital allocation: Expanded role for central banks to green global financial system

Photo provided by Climate Bonds Initiative

Responding to the risks 

Developing a brown taxonomy, shifting purchasing towards green assets and reviewing the doctrine of market neutrality are amongst the measures central banks and financial regulators (CBFR) should apply to address the systemic risk climate impacts pose to the global financial system. 

Produced by Climate Bonds Initiative in conjunction with the SOAS Centre for Sustainable Finance and WWF, Greening the Financial System: Tilting the playing field - The role of central banks is being released in the lead up to this year’s World Bank/IMF annual meetings in Washington D.C. 

Shifting capital to support transition 

Greening the Financial System analyses global progress by central banks in addressing climate issues. It advocates accelerated action by central banks and micro prudential regulators including greater use of prudential and regulatory powers, central bank asset purchases and credit guidance policy to:  

  • reduce systemic financial sector vulnerability to climate risks; 
  • increase global green capital allocations;
  • support transition amongst banks, insurers and other financial institutions. 

Major Recommendations: 

  • Central banks should develop a brown taxonomy. Central banks are uniquely concerned with the systemic risks to the financial system arising from financial institutions’ ownership of brown assets which are increasingly vulnerable to sharp revaluations and pricing volatility from climate mitigation policy and physical risks.
  • Central banks are major purchases of financial assets. The Eurozone central banks bought EUR2.6tn of assets (10% of Eurozone countries’ GDP) through the Asset Purchasing Programmes which are still replenishing holdings. Greening the Financial System recommends purchases be deliberately skewed to buying green assets, including assets on the primary market and recommends the doctrine of market neutrality be removed.
  • Central banks, through setting haircuts and weightings of different assets, greatly influence the assets held by banks and insurance companies for prudential regulation. Greening the Financial System recommends that the brown taxonomy be used to discourage use of brown assets as these are increasingly vulnerable to climate risks not yet captured by current climate models.
  • Central banks are understandably opposed to making the prudential regulations less stringent. Accordingly, they should test whether green supporting factors could be applied to offset some of the impact of using the brown penalising factors. Such a policy would encourage investment in green technologies through increasing the demand for the assets for regulatory purposes. 

Who’s saying what? 

Ulrich Volz, Founding Director of the SOAS Centre for Sustainable Finance, SOAS University of London: 

"Central banks and financial supervisors have a key role to play in ensuring that the financial sector addresses climate and other environmental risks and that financial flows are aligned with the Paris Agreement. Financial governance can be only part of a broader public policy response to addressing the climate crisis, however its role cannot be overstated.”

“This report provides an excellent overview of the current state of discussion and makes proposals that merit further scrutiny. While I don't agree with all of the report's recommendations, they will contribute to a much-needed discussion that will help central banks and supervisors develop adequate policies in response to the climate crisis."

Sebastien Godinot, Head Sustainable finance, WWF European Policy Office: 

“Central banks and regulators have important powers to ensure that environmental risks are assessed, disclosed and mitigated by financial institutions. This new report is an excellent review of the actions central banks and supervisors should take forward: we hope that climate scenario testing will rapidly become a new normal and, with more environmental risk disclosure, will accelerate the discussion about how to adjust risk weightings, collateral frameworks and monetary policies with sustainability factors."

Prashant Vaze, Head of Policy and Government, Climate Bonds Initiative:  

“There is increasing recognition by central banks of the growing structural and systemic risks that climate change poses to the financial system and the need for coordinated action. The establishmentof the NGFS has been a major step forward in that process. Developing and expanding response mechanisms using central banks prudential regulation & monetary policy toolkit to offset climate risk and support orderly transition is the next stage.” 

The last word

From not so sotto voce warnings in the latest from the NGFS, to the PRI’s early 2020s scenario forecasts via the Inevitable Policy Response, to Bank of England's chief Mark Carney’s recent addresses to the UN General Assembly and the TCFD Summit in Tokyo, 'risk' flags are being waved from multiple quarters at every player in the financial system. 

CBFR have an array of measures open to them to tilt the global playing field towards transition and rapid greening of capital deployment. As with every other aspect of climate action in the coming decade, it would be prudent to accelerate their implementation. 

 
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