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Finance and climate: Time for ‘green’ central banking?
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Last September, Mark Carney – who serves as both Governor of the Bank of England and Chairman of the G20’s Financial Stability Board – made a controversial speech on the relation between the financial system and climate change.


The speech was received with a certain perplexity. The traditional role of central bankers is to deal with price stability and support the banking system: since when do they concern themselves with the environment?




  • The ties between finance and the sustainability of the economic system are multiple and profound

  • A large-scale reallocation of both human and financial resources is needed

  • An idea that seems to obtain a certain consent is that of Green Quantitative Easing: i.e. a process whereby central banks create liquidity destined to finance investments in green sectors

But the solidity of the financial system is indeed Mark Carney’s primary concern when he chooses to talk about the possible effects of climate change. In fact, it has become increasingly clear in recent times that the ties between finance – broadly intended as the global credit system – and the sustainability of the economic system are multiple and profound, and they are set to grow even stronger. 


Carney identifies two main themes. First, that potential environmental disasters risk causing significant damage to infrastructures and productive capital: this would have significant repercussions on the insurance system.


Second, the implementation of emission reduction policies might lead to a dramatic fall in the value of those companies whose business is based on the extraction, distribution or use of fossil fuels, among which are some of the biggest companies in the entire world - Shell, BP, Exxon, Eni, and many others.


Indeed, if we hope to shift towards clean sources of energy and contain the temperature rise below the 2°C threshold, a significant portion of oil, gas and coal reserves must remain underground and not be extracted.


These deposits, which currently contribute to determining the value of the companies that own them, would thus become ‘stranded assets’ with an economic value close to zero. The collapse of these companies would risk triggering a systemic financial crisis, which in turn could lead to a recession, low employment and a general worsening of life conditions. 


A large-scale reallocation of both human and financial resources is thus needed. This must be managed in a way that is both prudent and forward-looking, in particular given that the alternative scenario – i.e. the continued use of fossil energy and acceptance of its effects in terms of climate instability – might hide much more catastrophic consequences.


In this context, the role of the institutions responsible for monetary policy and regulation of financial risk can be decisive. These could work to improve public information on the topic and ask the big banks and insurance companies to adopt cautious long-term measures to manage climate-related risks in order to minimise possibilities of a systemic crisis.


Or central banks could play a more active role in the process of credit allocation, by modifying private bank incentives with a view to expanding financial flows directed to investments in renewable energy and other ‘green’ business. 


This can happen in different ways. The Chinese Central Bank, for example, has initiated a broad research programme to try to make its financial system more sustainable from the energetic and environmental points of view, and has implemented a policy of ‘soft pressure’ towards banks to encourage them to lend more easily to green businesses.


The Bank of Lebanon has opted instead for relaxing the liquidity requirements for private banks that create credit in favour of investments which will lead to a reduction in CO2 emissions.


The French Prime Minister’s strategic think-tank France Stratégie has proposed a mechanism to finance European low-carbon investments through the creation by the Central Bank of ‘certificates’ in favour of businesses able to reduce emissions – these would function as assets that creditor private banks can then use at the Central Bank itself to satisfy their liquidity requirements.


Such policies are far from being ‘conventional’ – at least in comparison to the traditional habits of central banks in high-income regions, which for decades were used to deal exclusively with inflation.


On closer inspection, however, the recent behaviour of international central banks has been anything but conventional, and their range of functions and spheres of action have expanded significantly. First they lowered interest rates, which remain close to zero today.


Then they created unprecedented amounts of liquidity – with the so-called Quantitative Easing – in the hope of reviving a dying system of credit. At the same time, they set up programmes of public debt purchase that have the potential to save entire nations from crisis – an approach that only a few years ago was thought impossible – as well as mass buying up of ‘toxic’ private bonds.

In other words, from the beginning of the financial crisis onwards, central bankers took on increasing relevance on the global economic chessboard. Today, figures such as Mario Draghi and Janet Yellen have greater power to influence international social-economic dynamics than most heads of state.


In the face of such a profusion of measures to support the financial system, and the broad power of central bankers, a question comes to mind: is it possible to think of a monetary intervention that supports a sustainable economy?


For example, an idea that seems to obtain a certain consent is that of Green Quantitative Easing – i.e. a process whereby central banks create liquidity destined to finance investments in green sectors. Just as they purchased impressive amounts of sovereign debt bonds, they could also purchase the bonds issued by specific development banks – the UK Green Investment Bank, for instance – or other public institutions working towards sustainability.


Moreover, this wouldn’t be the first time such power is exercised. As the American Federal Reserve itself points out, the central banks of industrialised countries such as the USA have historically made large use of ‘macroprudential’ policies aimed at channelling credit flows towards sectors considered of strategic relevance, such as real estate for example.


In Canada they went a step further, creating an Industrial Development Bank to support small and medium businesses, whose operations were entirely financed by the Canadian Central Bank for over thirty years.

Several developing countries still implement a great variety of policies in support of specific sectors today, and sometimes also in favour of green investments, like in the cases of China and Lebanon we mentioned above. 


This scenario, of course, is not free of risk. The detachment of central banks from extra-monetary duties happened for good reasons – among these was the maintenance of their independence from the volatile decisions of national governments.


Were the central banks allowed to create incentives to favour low-carbon businesses, what would prevent them from ‘tampering’ further with the credit market, favouring other sectors and companies, perhaps at the service of politicians keen to be re-elected?


A careful mechanism of monitoring and balancing must be put in place as a way to reduce distortions and inefficiencies to a minimum. However, as risky as it may be to leave the power to decide on the creation and allocation of credit to the public bureaucrats, we find it hard to believe that entrusting this broad power to the sole hands of the private banking system – legitimately moved by the search of profit rather than the improvement of social wellbeing – would lead to better results.


The debate on the role of the financial system in the transition to a low-carbon economy will go well beyond the Paris conference, in which the main topics of discussion have been others.


In the ‘finance’ category, the question of resources flowing from high-income to developing countries – aimed at compensating the latter for their smaller degree of historical responsibility in terms of emissions and greater vulnerability to climate change – has greater space.


Despite the evident historical and political value of identifying and quantifying these flows, in the last analysis, these are mere crumbs compared with those that many developing countries would be able to generate through their domestic credit systems.


The green finance debate must thus be shifted to the national level, as the spark of transition can be more easily ignited by domestic resources. For this to happen however, the active support of the banking and financial system is absolutely necessary, in conceding the large amount of credit that is currently lacking. The role of Mark Carney and his colleagues in this process could be extremely precious.      


Further readings:


Emanuele Campiglio, Beyond carbon pricing: The role of banking and monetary policy in financing the transition to a low-carbon economy, in "Ecological Economics", Volume 121, January 2016


UNEP Inquiry: Design for a sustainable financial system



Translated by Teresa O’Connell


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