Central Banks Take on Climate Change

By Johanna Fernandes, Staff Writer

 Central Banks are mandated to support the financial and economic welfare of their countries. While they acted as a lifeline for the financial system over the pandemic, this year brings a hawkish pivot as leading economies overheat with unprecedented inflation. However, the ever-growing recognition of climate change and the overheating planet also spur considerable risk to financial stability. 

Central Banks are thought to be led independently of political and legislative branches. Typically, climate change is viewed as a political issue not to be fixed by interest rates and monetary policy. While climate regulation does not traditionally lay within mandates, some countries are adopting a more holistic approach.  

Climate risks present both physical and transition risks for markets. Physical refers to the damage created by extreme weather, and transition risks as institution’s face financial loss moving towards a lower-carbon economy. If these risks materialize, they pose credit, operational, market, and liquidity risks across the board. Kristalina Georgieva, the Managing Director of the International Monetary Fund, said: “When a country is hit by a natural disaster — and these disasters are becoming more frequent and more severe — then property is affected, production capacity of agriculture, of industry is affected, even the very financial institutions may be affected.” 

Christine Lagarde, the President of the European Central Bank (ECB), is a leader in the movement. During the State of the Union Conference, Lagarde said: “It is pretty obvious, climate change will have — has already — an impact on price stability, whether you look at climate related events, whether you look at particularly exposed areas, prices will be determined as a result of that.” 

ECB stress tests for climate risks faced by European banks are set to commence this quarter. They aim to prepare banks to understand the risks of potential losses from extreme weather or government policies that could put pressure on polluting industries. While the stress test won’t impact banks’ capital requirements, it does prepare them to incorporate climate risks into their frameworks. 

While the ECB is supported by climate progressive countries in the EU, the U.S. Federal reserve treads carefully to remain politically neutral in their mandate. That is until last Monday, when Fed Chair Jerome Powell announced that climate stress tests for banks will likely “be a very important priority” in supervision. Powell still acknowledges that the Fed’s role in climate change is limited but important. The U.S., often viewed as a laggard in this field, signals a shift towards climate action that was previously ignored. 

Central banks are looking beyond climate stress tests to make an impact. Other monetary policy efforts could entail mandatory climate-risk disclosure rules and asset purchase programs to limit exposure to industries with high greenhouse-gas emissions. The scope of action varies amongst Banks: 

  • The People’s Bank of China provides sustainable investments and incentives green financial products 
  • The Bank of England has greened their corporate bond purchasing program and is introducing climate stress tests 
  • The ECB is modeling climate risks, introducing climate stress tests, and has greened their asset purchase program 
  • The Bank of Canada is monitoring climate risks, encouraging corporations to make these considerations, and is assisting in the efficient allocation of capital to more sustainable investments  

All these actions show that what was once thought of as a strictly policy issue is now becoming a consideration in monetary policy. It remains to be seen how far these policies will go when it  comes to tackling the climate crisis, but these actions show how deeply ingrained this issue has become across the globe.

Photo by Li-An Lim on Unsplash

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