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2021 | OriginalPaper | Chapter

7. Climate Change as a Systemic Risk in Finance: Are Macroprudential Authorities Up to the Task?

Author : Seraina Grünewald

Published in: Sustainable Finance in Europe

Publisher: Springer International Publishing

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Abstract

There is growing acknowledgement among policymakers that climate change may give rise to potentially catastrophic financial risk and impact financial stability. This chapter explores the specific features of climate-related financial risks (CRFR), drawing on a growing body of macrofinancial literature and policy work, and discusses the options macroprudential policymakers have in the face of such risk. It finds that there are significant challenges associated with ‘greening’ macroprudential policy, both epistemological and methodological as well as behavioural, and points to potential ingredients of a ‘green’ macroprudential policy. In the light of the radical uncertainty in relation to the dynamics of CRFR, the timing of policy action is of the essence. The chapter, in particular, explores the merits and challenges associated with a precautionary approach to tackling the systemic effects of CRFR. Finally, it briefly discusses the role that Central Banks can and should play in the transition to a low-carbon economy, both within the confines and in fulfilment of their price and financial stability mandates.

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previous chapter Integrating Sustainability in EU Corporate Governance Codes

next chapter Climate Change as a Threat to Financial Stability: Can Solutions to This Problem Accelerate the Transition to a Low-Carbon Economy? A Critical Review of Policy and Market-Based Approaches

Intergovernmental Panel on Climate change (IPCC, 2014), Climate change 2014: Synthesis Report, Contribution of Working Groups I, II and III to the Fifth Assessment Report of the Intergovernmental Panel on Climate change.

For example, Network for Greening the Financial System (NGFS, 2019), A call for action: Climate change as a source of financial risk, First comprehensive report, April; Network for Greening the Financial System (NGFS, 2018), First Progress Report, October; Batten, Sandra et al. (2016). Let Talk About the Weather: The Impact of Climate Change on Central Banks, Bank of England Staff Working Paper No. 603, May; Carney, Mark. (2015). Breaking the Tragedy of the Horizon—Climate Change and Financial Stability, speech at Lloyd’s of London, 29 September. Some refer to liability risks as a third channel. In this chapter, liability risks are treated as physical risks that may manifest themselves as liability risks.

On the effects of the ‘carbon bubble’ on the EU banking sector, Weyzig, Francis. (2014). The Price of Doing Too Little Too Late: The Impact of the Carbon on the European Financial System. Green New Deal Series, Vol. 11, February.

For example, Network for Greening the Financial System (NGFS, 2019), A call for action: Climate change as a source of financial risk, First comprehensive report, April, pp. 14, 17; Grippa, Pierpaolo et al. (2019). Climate Change and Financial Risk, IMF Finance & Development, December, p. 27; Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 20.

Network for Greening the Financial System (NGFS, 2019), A call for action: Climate change as a source of financial risk, First comprehensive report, April, pp. 14, 17; Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, pp. 19–20. On transmission and amplification by the financial system, Financial Stability Board (FSB, 2020), The implications of climate change for financial stability, 23 November, pp. 17–25.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 18.

See Network for Greening the Financial System (NGFS, 2019), A call for action: Climate change as a source of financial risk, First comprehensive report, April, p. 21; Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 19.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 3.

The Network for Greening the Financial System (NGFS), founded in 2017, consists of an ever-growing group of currently 89 member Central Banks and financial supervisors (as of March 19, 2021) and aims to strengthen the role of the financial sector in managing climate-related risks and mobilising capital to enable the low-carbon transition. For an overview of initiatives taken with a view to Basel Committee on Banking Supervision (BCBS, 2020), Climate-related financial risks: a survey on current initiatives, April.

Network for Greening the Financial System (NGFS, 2019), A call for action: Climate change as a source of financial risk, First comprehensive report, April; and Network for Greening the Financial System (NGFS, 2020), Guide for supervisors—Integrating climate-related and environmental risks into prudential supervision, Technical document, May; more recently also Financial Stability Board (FSB, 2020), Stocktake of financial authorities’ experience in including physical and transition climate risks as part of their financial stability monitoring, July 22; and Financial Stability Board (FSB, 2020), The implications of climate change for financial stability, 23 November. On research priorities with a view to Network for Greening the Financial System (NGFS, 2020), the macroeconomic and financial stability impacts of climate change—Research priorities, Technical document, June.

For example, Battiston/Monasterolo, in: Alessi Lucia (ed.) (2020), JRC Conference and Workshop Report, Joint JRC-EBA workshop on banking regulation and sustainability, p. 46; Network for Greening the Financial System (NGFS, 2019), Macroeconomic and financial stability implications of climate change, Technical supplement to the first comprehensive report, July, p. 3; Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, p. 8.

See, in particular, Weitzman, Martin L. (2011). Fat-Tailed Uncertainty in the Economics of Catastrophic Climate Change. Review of Environmental Economics and Policy, 5(2), 277: ‘The unprecedented scale and speed of [greenhouse gas] increases brings us into uncharted territory and makes predictions of future climate change very uncertain. Looking ahead a century or two, the levels of atmospheric GHGs that may ultimately be attained (unless decisive measures are undertaken) have likely not existed for tens of millions of years, and the speed of this change may be unique on a time scale of hundreds of millions of years.’

‘Tipping points’ are commonly understood as critical thresholds at which small perturbations can lead to large and long-term qualitative changes of the state or future development of a system. See Lenton, Timothy M. et al. (2008). Tipping Elements in the Earth’s Climate System. Proceedings of the National Academy of Sciences of the United States of America, 105(6), 1786–1793.

See Network for Greening the Financial System (NGFS, 2020), NGFS climate scenarios for Central Banks and supervisors, June; Network for Greening the Financial System (NGFS, 2020), Guide to climate scenario analysis for Central Banks and supervisors, Technical document, June. On the merits of scenario analysis in a microprudential setup Task Force on Climate-related Financial Disclosures (TCFD, 2017), Final Report, June, pp. 25–30; Task Force on Climate-related Financial Disclosures (TCFD, 2017), The use of scenario analysis in disclosure and climate-related risks and opportunities, June.

On climate stress testing Adrian, Tobias et al. (2020), Stress testing at the IMF, Monetary and Capital Markets Department, No. 20/04, pp. 45–47 (Chapter 9).

See Battiston/Monasterolo, in: Alessi Lucia (ed.) (2020), JRC Conference and Workshop Report, Joint JRC-EBA workshop on banking regulation and sustainabilityAlessi, pp. 41–43; Network for Greening the Financial System (NGFS, 2019a), A call for action: Climate change as a source of financial risk, First comprehensive report, April, pp. 20–22, 24–27; Network for Greening the Financial System (NGFS, 2019b), Macroeconomic and financial stability implications of climate change, Technical supplement to the first comprehensive report, July, pp. 27–31.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, pp. 42–46.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, pp. 23–46; Hugues, C. et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13. On climate change uncertainties and their policy implications Pindyck, Robert S. (2020). What We Know and Don’t Know About Climate Change, and Implications for Policy, NBER Working Paper No. 27304, June.

King Mervyn. (2017). The End of Alchemy: Money, Banking, and the Future of the Global Economy. W.W. Norton, p. 87.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 43; Pereira da Silva, Luiz Awazu. (2019). Research on Climate-Related Risks and Financial Stability: An ‘Epistemological Break’?, Remarks at the Conference of the Central Banks and Supervisors Network for Greening the Financial System (NGFS), Paris, 17 April.

See Kay John & King Mervyn. (2020). Radical Uncertainty: Decision-Making Beyond the Numbers. W.W. Norton; King Mervyn. (2017). The End of Alchemy: Money, Banking, and the Future of the Global Economy. W.W. Norton.

For example, Houben, Aerdt et al. (2019). “Introduction”, in Aerdt Houben et al. (eds.), Putting Macroprudential Policy to Work, De Nederlandsche Bank, Occasional Studies, Vol. 12–7, 17 January, pp. 11–14; European Systemic Risk Board (ESRB, 2019), The ESRB Handbook on operationalising macro-prudential policy in the banking sector, 17 January, pp. 172–180. From a legal perspective Schammo, Pierre. (2019). “Inaction in Macro-Prudential Supervision: Assessing the EU’s Response”. Journal of Financial Regulation, 5, 1–28.

Fundamentally Reinhart Carmen, M., & Rogoff, Kenneth S. (2009). This Time Is Different: Eight Centuries of Financial Folly. Princeton University Press.

Carney, Mark. (2015). Breaking the Tragedy of the Horizon—Climate Change and Financial Stability, speech at Lloyd’s of London, 29 September.

Bolton/Kacperczyk find that institutional investors are already demanding compensation for their exposure to carbon emission risk, see Bolton, Patrick, & Kacperczyk, Marcin, Do Investors Care About Carbon Risk?, NBER Working Paper No. 26968, April. See, however, International Monetary Fund (IMF, 2020), Global financial stability report, April, pp. 85–102 (Chapter 5), finding that physical risk does not seem to be reflected in global equity valuations.

See Financial Stability Board (FSB, 2020), The implications of climate change for financial stability, 23 November, p. 31.

In the EU, these developments are of course partially driven by the (binding) legal requirements introduced by Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks, OJ L 317, 9.12.2019, p. 17 (‘Benchmark Regulation’); Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector, OJ L 317, 9.12.2019, p. 1 (‘Sustainable Finance Disclosure Regulation’); and Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, OJ L 198, 22.6.2020, p. 13 (‘Taxonomy Regulation’).

Pereira da Silva, Luiz Awazu. (2019). Research on Climate-Related Risks and Financial Stability: An ‘Epistemological Break’?, Remarks at the Conference of the Central Banks and Supervisors Network for Greening the Financial System (NGFS), Paris, 17 April.

Section 7.4 below.

See section 7.2 above.

Task Force on Climate-related Financial Disclosures (TCFD, 2017), Final Report, June. For the status of implementation of the TCFD recommendations see Task Force on Climate-related Financial Disclosures (TCFD, 2020), 2020 Status Report, October.

On these limitations see section 7.3.1 above.

Importantly, some ‘green’ sectors may not succeed in the transition.

For example, Galati, Gabriele, & Moessner, Richhild. (2013). “Macroprudential Policy: A Literature Review”. Journal of Economic Surveys, 27(5), 850–852; Borio, Claudio, & Drehmann, Mathias. (2009). Towards an Operational Framework for Financial Stability: ‘Fuzzy’ Measurement and Its Consequences. In Banco Central de Chile (ed.), Financial Stability, Monetary Policy and Central Banking (also available as BIS Working Paper No. 284).

See the data available from NASA—Global Climate Change, https://climate.nasa.gov/vital-signs/carbon-dioxide/.

For example, Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, pp. 50-52; Cullen, Jay. (2018). “After ‘HLEG’: EU Banks, Climate Change Abatement and the Precautionary Principle”. Cambridge Yearbook of European Studies, 20, 80–86; Alexander, Kern. (2016). Greening Banking Policy, Input Paper for the G-20 Green Finance Study Group (GFSG); Schoenmaker, Dirk, & van Tilburg, Rens. (2016). “What Role for Financial Supervisors in Addressing Environmental Risks?” Comparative Economic Studies, 58, 317–334; Schoenmaker, Dirk & van Tilburg, Rens. (2016). Financial Risks and Opportunities in the Time of Climate Change, Bruegel Policy Brief 2016/02, April. Critical for the time being Nieto, Maria. (2019). “Banks, Climate Risk and Financial Stability”. Journal of Financial Regulation and Compliance, 27(2), 243–262.

See Network for Greening the Financial System (NGFS, 2020), Guide for supervisors—Integrating climate-related and environmental risks into prudential supervision, Technical document, May, pp. 52–57.

High-Level Expert Group on Sustainable Finance (HLEG, 2018), Financing a sustainable European economy, Final report, p. 68. The report explicitly refers to a statement in favour of a GSF made by Commission Vice-President Dombrovskis (see Dombrovskis, Valdis. (2017). “Greening Finance for Sustainable Business”, speech, 12 December, available at: https://ec.europa.eu/commission/presscorner/detail/en/SPEECH_17_5235).

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, OJ L 176, 27.6.2013, p. 1, as amended by Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the Net Stable Funding Ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012, OJ L 150, 7.6.2019, p. 1.

Article 501a CRR provides that own funds requirements for credit risk shall be multiplied by 0.75, if the exposure complies with all of the requirements set out in Article 501a(1)(a)-(o) CRR. According to lit. o, the obligor must carry out an assessment whether the assets being financed contribute to the following environmental objectives: climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy, waste prevention and recycling; pollution prevention and control; protection of healthy ecosystems (emphasis added).

For example, Cullen, Jay. (2018). “After ‘HLEG’: EU Banks, Climate Change Abatement and the Precautionary Principle”. Cambridge Yearbook of European Studies, 20, 82–84; van Lerven, Frank, & Ryan-Collins, Josh. (2018). Adjusting Banks’ Capital Requirements in Line with Sustainable Finance Objectives: Briefing Note, New Economics Foundation, 28 February; Matikainen, Sini et al. (2017). The Climate Impact of Quantitative Easing, Grantham Research Institute on Climate change and the Environment, Policy Paper, May.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 53; Thomä, Jakob, & Gibhardt, Kyra. (2019). “Quantifying the Potential Impact of a Green Supporting Factor or Brown Penalty on European Banks and Lending”. Journal of Financial Regulation and Compliance, 27(3), 380–394; Cullen, Jay. (2018). “After ‘HLEG’: EU Banks, Climate Change Abatement and the Precautionary Principle”. Cambridge Yearbook of European Studies, 20, 82–84.

See also Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 51; D’Orazio, Paola, & Popoyan, Lilit. (2019). “Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?”. Ecological Economics, 160, 29; Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, p. 17.

Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, p. 17. With the further development of the framework of the Taxonomy Regulation (n. 28), in particular the adoption of the corresponding Level 2 acts, this may change in the near future.

European Banking Authority (EBA, 2019), EBA Action plan on sustainable finance, 6 December.

Prudential Regulation Authority (PRA, 2019), Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change, Supervisory Statement 3/19, April.

Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin, 2020), Guidance notice on dealing with sustainability risks, 15 January.

Finanzmarktaufsicht (FMA, 2020), FMA-Leitfaden zum Umgang mit Nachhaltigkeitsrisiken, 2 July.

De Nederlansche Bank (DNB, 2020), Good practice—Integration of climate-related risk considerations into banks’ risk management, 1 April. See also the accompanying Q&A at https://www.toezicht.dnb.nl/3/50-238191.jsp.

European Central Bank (ECB, 2020), Guide on climate-related and environmental risks, Supervisory expectations relating to risk management and disclosure, May.

Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, OJ L 176, 27.6.2013, p. 338, as amended by Directive (EU) 2019/878 of the European Parliament and of the Council of 20 May 2019 amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures, OJ L 150, 7.6.2019, p. 263.

European Banking Authority (EBA, 2020), Final Report: Guidelines on loan origination and monitoring, 29 May, EBA/GL/2020/06.

See also Network for Greening the Financial System (NGFS, 2019), A call for action: Climate change as a source of financial risk, First comprehensive report, April, p. 27: ‘authorities can set out their expectations when it comes to financial firms’ transparency on climate-related issues’.

Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups, OJ L 330, 15.11.2014, p. 1.

European Banking Authority (EBA, 2019), EBA Action plan on sustainable finance, 6 December, pp. 16–17.

Article 434a CRR. The EBA has issued a survey on the matter; see European Banking Authority (EBA, 2020), Survey: Pillar 3 disclosures on ESG risks under Article 449a CRR, 17 September.

Loi relative à la transition énergétique pour la croissance verte (2015).

For example, Narbel, Patrick. (2013). The Likely Impact of Basel III on a Bank’s Appetite for Renewable Energy Financing, Norwegian School of Economics Department of Business and Management Science Discussion Paper No. 2013/10, October; Liebreich, Michael, & McCrone, Anguns. (2013). Financial Regulation—Biased Against Clean Energy and green Infrastructure?, Bloomber New Energy Finance, Clean Energy—White Paper, 20, pp. 3–4. See also the policy recommendation to introduce a precise incentive mechanism for the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) to link climate-related and maturity mismatch considerations in European Banking Federation (EBF, 2017), Towards a green finance framework, 28 September, p. 34.

D’Orazio, Paola, & Popoyan, Lilit. (2019). “Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?” Ecological Economics, 160, 30.

D’Orazio, Paola, & Popoyan, Lilit. (2019). “Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?” Ecological Economics, 160, 31.

D’Orazio, Paola, & Popoyan, Lilit. (2019). “Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?” Ecological Economics, 160, 32–33. For example, banks and other financial institutions in Bangladesh are required to allocate 5% of their total loan portfolio to ‘green’ sectors (Dikau, Simon, & Ryan-Collins, Josh. (2017). Green Central Banking in Emerging Market and Developing Country Economies, New Economic Foundation, p. 19).

D’Orazio, Paola, & Popoyan, Lilit. (2019). “Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?” Ecological Economics, 160, 29–30; see also Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 53.

Nieto, Maria. (2019). “Banks, Climate Risk and Financial Stability”. Journal of Financial Regulation and Compliance, 27(2), p. 257; Advisory Scientific Committee (ASC) of the European Systemic Risk Board (ESRB, 2016), Too late, too sudden: Transition to a low-carbon economy and systemic risk, Report No. 6, p. 17; Schoenmaker, Dirk, & van Tilburg, Rens. (2016). “What Role for Financial Supervisors in Addressing Environmental Risks?” Comparative Economic Studies, 58, 317–334; Schoenmaker, Dirk & van Tilburg, Rens. (2016b). Financial Risks and Opportunities in the Time of Climate Change, Bruegel Policy Brief 2016/02, April.

D’Orazio, Paola, & Popoyan, Lilit. (2019). “Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?” Ecological Economics, 160, 33.

See sections 7.2 and 7.3.1 above.

Critical Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13; Cullen, Jay. (2018). “After ‘HLEG’: EU Banks, Climate Change Abatement and the Precautionary Principle”. Cambridge Yearbook of European Studies, 20, 61–87.

Network for Greening the Financial System (NGFS, 2019a), A call for action: Climate change as a source of financial risk, First comprehensive report, April, pp. 22–28. Building on the approach of the call for action Network for Greening the Financial System (NGFS, 2020), Guide for supervisors—Integrating climate-related and environmental risks into prudential supervision, Technical document, May.

Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions, Action Plan: Financing Sustainable Growth, 8 March 2018, COM(2018) 97 final. However, in its consultation on the renewed sustainable finance strategy, the Commission contemplated to scale up the efforts of integrating ESG considerations into the prudential frameworks for banks and insurances. See European Commission (EC, 2020), Consulation document, Consulation on the renewed sustainable finance strategy, 8 April.

High-Level Expert Group on Sustainable Finance (HLEG, 2018), Financing a sustainable European economy, Final report.

The only (narrow) exception being Article 501a CRR, which applies a GSF (of 0.75) to lending to infrastructure project entities contributing to environmental objectives. The Commission is mandated to report on the impact of this GSF (with the support of EBA) by 28 June 2022.

According to Article 501c CCR, the EBA is mandated to assess whether a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental and/or social objectives would be justified. It is expected to submit a report on its findings only by 28 June 2025, on the basis of which the Commission may (or may not) submit a legislative proposal. See also European Banking Authority (EBA, 2019), EBA Action plan on sustainable finance, 6 December, p. 13.

Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, p. 2.

Article 3.3 of the UN Framework Convention on Climate change (UNFCC) of 1992 states: ‘The Parties should take precautionary measures to anticipate, prevent or minimize the causes of climate change and mitigate its adverse effects. Where there are threats of serious or irreversible damage, lack of full scientific certainty should not be used as a reason for postponing such measures, (…).’

Treaty on the Functioning of the European Union, OJ C 326, 26.10.2012, p. 47.

Communication from the Commission on the precautionary principle, 2 February 2000, COM(2000) 1 final, pp. 8-10. For further examples see Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, pp. 12–13; Cullen, Jay. (2018). “After ‘HLEG’: EU Banks, Climate Change Abatement and the Precautionary Principle”. Cambridge Yearbook of European Studies, 20, 78–80.

Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, pp. 15–16.

Most Central Banks remain critical of an active ‘leaning against the wind’ with monetary policy.

See also Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, pp. 14–15.

See section 7.3.2 above.

For example, Bank of England. (2009). The Role of Macroprudential Policy: A Discussion Paper, November; Borio, Claudio, & Drehmann, Mathias. (2009). Towards an Operational Framework for Financial Stability: ‘Fuzzy’ Measurement and Its Consequences. In Banco Central de Chile (ed.), Financial Stability, Monetary Policy and Central Banking (also available as BIS Working Paper No. 284).

Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, pp. 22–23.

See section 7.3.2 above.

Borio, Claudio. (2011). “Implementing a Macroprudential Framework: Blending Boldness and Realism”. Capitalism and Society, 6(1), 1–25.

See Chenet, Hugues et al. (2019). Climate-Related Financial Policy in a World of Radical Uncertainty: Towards a Precautionary Approach, UCL Working Paper 2019-13, pp. 22–23. Arguing for simplicity in light of radical uncertainty King Mervyn. (2016). The End of Alchemy: Money, Banking, and the Future of the Global Economy. W.W. Norton, Chapter 4.

Similarly Fisher, Paul, & Alexander, Kern. (2019). Climate Change: The Role for Central Banks, King’s Business School Working Paper No. 2019/6, April.

Other core tasks of Central Banks include issuing banknotes; providing clearing and settlement accounts for the banking system; and responsibility for payment systems.

The adoption of non-standard monetary policy measures, which pursue financial stability as a second-order or intermediate objective, has blurred the line between monetary and macroprudential policy.

For example, Krogstrup, Signe, & Oman, William. (2019). Macroeconomic and Financial Policies for Climate Change Mitigation: A Review of the Literature. IMF Working Paper 19/185, September, amongst many others.

For a framework for assessing the social cost of carbon Barnett, Michael et al. (2020). “Pricing Uncertainty Induced by Climate Change”. The Review of Financial Studies, 33(3), 1024–1066.

See Network for Greening the Financial System (NGFS, 2020), Climate change and monetary policy—Initial takeaways, Technical document, June.

See Krogstrup, Signe, & Oman, William. (2019). Macroeconomic and Financial Policies for Climate Change Mitigation: A Review of the Literature. IMF Working Paper 19/185, September, p. 30; Fisher, Paul, & Alexander, Kern. (2019). Climate Change: The Role for Central Banks, King’s Business School Working Paper No. 2019/6, April, p. 8. For potential adaptation policies see, e.g., Fisher & Alexander (2019), pp. 9–11; Coeuré, Benoît. (2018). Monetary policy and climate change, Speech given at a conference on ‘Scaling up Green Finance: The Role of Central Banks,’ organized by the Network for Greening the Financial System, the Deutsche Bundesbank and the Council on Economic Policies, Berlin, November 8; McKibbin, Warwick J. et al. (2017). Climate change and Monetary Policy: Dealing with Disruption, Climate and Energy Economics Discussion Paper, Brookings, Washington DC, November 30.

Rudebusch, Glenn D. (2019), Climate Change and the Federal Reserve, FRBSF Economic Letter 2019-09, March 25, p. 3; Krogstrup, Signe, & Oman, William. (2019). Macroeconomic and Financial Policies for Climate Change Mitigation: A Review of the Literature. IMF Working Paper 19/185, September, p. 30; see also Batten, Sandra et al. (2016). Let Talk About the Weather: The Impact of Climate Change on Central Banks, Bank of England Staff Working Paper No. 603, May, pp. 23–27.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, pp. 9, 47.

Central Bank mandates often include the contribution to general economic welfare additional to price stability (Dikau, Simon, & Volz, Ulrich. [2019]. Central Bank Mandates, Sustainability Objectives and the Promotion of Green Finance, SOAS Department of Economics, Working Paper No. 222, March). For the case of the ECB see Lastra, Rosa, & Alexander, Kern. (2020). The ECB Mandate: Perspectives on Sustainability and Solidarity, Monetary Dialogue Papers, June.

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, pp. 47–64.

Coeuré, Benoît. (2018). Monetary policy and climate change, Speech given at a conference on ‘Scaling up Green Finance: The Role of Central Banks,’ organized by the Network for Greening the Financial System, the Deutsche Bundesbank and the Council on Economic Policies, Berlin, November 8.

An ad hoc case in point being the ECB’s involvement in the ‘Troika’ along with the Commission and the International Monetary Fund (IMF). Within macroprudential bodies, Central Bank representatives are also bound to take decisions collectively with Central Bank outsiders (e.g. supervisors, expert individuals, politicians).

Koedijk, Kees G. et al. (2018). “Monetary Policy, Macroprudential Regulation and Inequality: An Introduction to the Special Section”. Journal of International Money and Finance, 85, 163–167.

100

Dikau, Simon, & Volz, Ulrich. (2019). Central Bank Mandates, Sustainability Objectives and the Promotion of Green Finance, SOAS Department of Economics, Working Paper No. 222, March; Coeuré, Benoît. (2018). Monetary policy and climate change, Speech given at a conference on ‘Scaling up Green Finance: The Role of Central Banks,’ organized by the Network for Greening the Financial System, the Deutsche Bundesbank and the Council on Economic Policies, Berlin, November 8; Carney, Mark. (2015). Breaking the Tragedy of the Horizon—Climate Change and Financial Stability, speech at Lloyd’s of London, 29 September.

101

Battiston, Stefano, & Irene, Monasterolo. (2019). How Could the ECB’s Monetary Policy Support the Sustainable Finance Transition?, March, available at: https://www.finexus.uzh.ch/en/news/cspp_sustainable_finance.html; Matikainen, Sini et al. (2017). The Climate Impact of Quantitative Easing, Grantham Research Institute on Climate Change and the Environment, Policy Paper, May.

102

Some Central Banks traditionally adhere to a doctrine of market neutrality, i.e., they seek to minimize distortive effects of their monetary policies on markets’ price discovery mechanisms. The merits of such doctrine, however, are questionable in light of the persistent mispricing of CRFR due to multiple market failures.

103

Similarly Krogstrup, Signe, & Oman, William. (2019). Macroeconomic and Financial Policies for Climate Change Mitigation: A Review of the Literature. IMF Working Paper 19/185, September, p. 31 (‘it is against mandates not to reflect risks appropriately’); Monnin, Pierre. (2018). Central Banks and the Transition to a Low-Carbon Economy, CEP Discussion Note 2018/1, March.

104

Mauderer, Sabine. (2020). Central Banks Have a Part to Play in the Fight Against Climate Change, Financial Times, February 27.

105

For example, van Lerven, Frank, & Ryan-Collins, Josh. (2018). Adjusting Banks’ Capital Requirements in Line with Sustainable Finance Objectives: Briefing Note, New Economics Foundation; Ryan-Collins, Josh et al. (2013). Strategic Quantitative Easing: Stimulating Investment to Rebalance the Economy, New Economics Foundation. On the discussion in the Eurozone De Grauwe, Paul. (2019). Green Money Without Inflation, Council on Economic Policies Blog, March 7.

106

See also Krogstrup, Signe, & Oman, William. (2019). Macroeconomic and Financial Policies for Climate Change Mitigation: A Review of the Literature. IMF Working Paper 19/185, September, pp. 31–32.

107

Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 47, speak of a ‘third role’ of Central Banks (besides price and financial stability). A recent example for such reinterpreation is the Bank of England, whose mandate was upgraded in early March 2021 to include support to the U.K. government's strategy to transition to a net zero economy.

108

Aglietta, Michel et al. (2015). A Proposal to Finance Low-Carbon Investment in Europe, La Note D’Analyse No. 4, France Stratégie, Paris.

109

Fisher, Paul, & Alexander, Kern. (2019). Climate Change: The Role for Central Banks, King’s Business School Working Paper No. 2019/6, April, pp. 14, 16.

110

Specifically on the question of the extent to which the TCFD framework may also be useful for Central Bank disclosures Network for Greening the Financial System (NGFS, 2019), A sustainable and responsible investment guide for Central Banks’ portfolio management, October, pp. 21–22.

111

See the discussion in Bolton, Patrick et al. (2020). The Green Swan—Central Banking and Financial Stability in the Age of Climate Change, January, p. 54.

112

For example, the Green Bond Investment Pools launched by the BIS. Other strategies include: negative screening; best-in-class; ESG integration; and voting and engagement (Network for Greening the Financial System [NGFS, 2019], A sustainable and responsible investment guide for Central Banks’ portfolio management, October, pp. 12–19).

113

Typical Central Bank portfolios include: policy portfolios; own portfolios; pension portfolios; and third-party portfolios (Network for Greening the Financial System [NGFS, 2019], A sustainable and responsible investment guide for Central Banks’ portfolio management, October, pp. 7–9).

114

The rules of logic tell us that: ‘[i]t is better to be vaguely right than precisely wrong’ (Read Carveth [1914], Logic: Deductive and Inductive, 4th edition, London [Project Gutenberg e-book, 2006], p. 351). King Mervyn. (2016). The End of Alchemy: Money, Banking, and the Future of the Global Economy. W.W. Norton, Chapter 4, famously uses this quote, arguing in favour of simple coping strategies when faced with uncertainty.

Title: Climate Change as a Systemic Risk in Finance: Are Macroprudential Authorities Up to the Task?
Author: Seraina Grünewald
Publisher: Springer International Publishing
Book: Sustainable Finance in Europe
Print ISBN: 978-3-030-71833-6

Electronic ISBN: 978-3-030-71834-3

Copyright Year: 2021
DOI: https://doi.org/10.1007/978-3-030-71834-3_7

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