Move over, negative rates. There is a new issue baffling and dividing those running the world’s central banks: should they be helping to fight climate change? The answer has to be yes — within their mandates. For most central banks, that means taking significantly more action. But governments have their own part to play in spurring on indispensable market development.
The debate has been muddled because it has often conflated different aspects of central banks’ mandates: monetary policy, financial stability and management of ultimately government-owned assets. These differ widely in the degree to which they both require and permit taking climate change into account.
There is now a wide consensus that climate change is a financial stability risk. Research by BlackRock shows that asset prices often do not reflect true exposure to physical climate risks and those related to energy transition. Central banks have a responsibility to make the financial institutions they supervise treat these risks as rigorously as any other and many have begun to do so, following the Bank of England’s lead.
But so far there has been only limited movement towards applying the same logic to central banks’ own balance sheets — in fact, none in the form of haircuts on collateral and only a little in the form of investment universe definition. Yet central banks, too, should care about their true risk exposure. That risk may be negligible in portfolios consisting almost exclusively of high-grade government bonds, but many central banks now own substantial amounts of corporate bonds, mortgage-backed securities and equities, for which climate risk can be substantial.
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Despite notable efforts by the Network for Greening the Financial System, there is much less consensus around using central bank balance sheets to fight climate change. Surveys indicate that some have started doing this in their portfolios unrelated to monetary policies, such as foreign exchange reserves, and more are in the process of considering it. But most are doing neither.
Caution is warranted: these portfolios have clear objectives — safety, liquidity and return for FX reserves, and specific risk-return targets for investment portfolios. Until relatively recently, it was not clear that a portfolio could be made more climate friendly without meaningful trade-off with these objectives. But financial markets have evolved, and research now suggests that it is possible to do so.
That leaves monetary policy portfolios. Here, the consensus is on strict market neutrality — that is to say, no green tilt. The case against such a tilt is clear. It is a slippery slope: today climate change, tomorrow social inequality and more. On the other hand, many central banks have a secondary mandate to support the general economic policies of the government (or the EU in the case of the European Central Bank). Where these policies make fighting climate change a priority, shouldn’t the central bank then ask itself whether strict market neutrality, irrespective of whether it is necessary to achieve its price stability objective, is fully consistent with its mandate?
Central banks have a leading role to play in ensuring climate change doesn’t jeopardise financial stability. But they are also, now and for the foreseeable future, very large owners of assets that ultimately belong to the public. Wherever it is government policy to prevent and mitigate climate change, it logically follows that central banks should manage these assets to contribute to this goal as far as possible, without compromising their primary objectives. Their capacity to do this will increase as governments, agencies and the private sector increase climate disclosures and issuance of green securities.
