“Whatever it takes.” Those words of Mario Draghi’s in 2012 reverberated with power. Politicians might dither, he implied, but the European Central Bank he led would “within our mandate… preserve the euro”.
The ECB succeeded absolutely. With limitless monetary firepower, it drove back the bears snarling at the eurozone.
When the coronavirus pandemic struck, no one doubted that central banks would respond with an arsenal of policies to prevent a health and economic crisis becoming a financial one.
In late September Christine Lagarde, Draghi’s successor, was able to declare “we have prevented a massive deterioration that would otherwise have been seen”.
But behind Covid-19 lurks a far greater threat: climate change. Policymakers of all kinds have known it was coming since the 1980s, but barely lifted a finger. Now, it is inflicting damage on lives and assets that cannot be ignored. Nearly all governments have promised to take some action, and a few — including the EU, the UK and China — have grasped the nettle and set targets to reach zero net greenhouse gas emissions.
Financial specialists have grown used to central banks being the most potent and — from their point of view — rational actors on the scene. They naturally expect them to wield their magic to defeat this evil. But do they have the necessary might? And do they dare to use it?
Getting together
So far, central banks are not keen to talk big about what they can achieve in this field. But they are certainly doing a lot of talking.
Although each central bank has its own national mandate and operations (or, for the ECB, multinational), they are a community that likes to interact. Responding to climate change requires fresh thinking and policies not found in their classical toolboxes, and possibly reinterpreting or stretching their mandates. When venturing into the unknown, central banks feel there is safety in numbers.
The Central Banks’ and Supervisors’ Network on Greening the Financial System (NGFS), formed as a quiet club of eight central banks in December 2017, has swiftly become one of the most prominent and influential green finance organisations.
Its 72 members come from nearly all major economies. “It’s clearly creating momentum in a lot of countries,” says Orith Azoulay, global head of green and sustainable finance at Natixis in Paris. “It is one of those initiatives where you start to be remarked when you are not in it, rather than when you are, which is the sign of a successful initiative.”
Among G20 members, only Argentina, India, Saudi Arabia and Turkey are not involved. From the US, the Dept of Financial Services of the State of New York has joined.
“Virtually all central banks and supervisors are starting to do something on the climate front, though the level varies very much,” says Morgan Després, deputy head of financial stability at the Banque de France, who heads the NGFS secretariat.
The early involvement of the People’s Bank of China and Mexican and Brazilian central banks has been crucial, argues Nick Robins, professor in practice in sustainable finance at the Grantham Institute of the London School of Economics. “One of the things that has made the agenda take off is that it’s no longer the preserve of Europeans,” he says. “South Africa and China are more carbon-intensive economies than Europe, and emerging economies are the most exposed to physical risks. So the case for thinking it through very seriously is much greater in emerging economies.”
The NGFS has produced a wealth of studies and documents to share best practices. Its achievements are particularly impressive in two areas. It has succeeded in making the central banking community accept that climate change is part of its remit, because it threatens financial stability.
But that does not mean central banks know how to tackle the problem — or even talk about it. The NGFS has started to provide a language, by showing how to break the issues down into parts and assess where and how they will impact the financial system.
The pinnacle so far is its detailed guide, published in June, to climate scenario analysis. It lays out three kinds of scenario: orderly transition, disorderly transition and hothouse world, in a total of eight versions.
Having standard scenarios is crucial if central banks, with their supervisory spectacles on, are to steer the banks and insurance companies they regulate away from climate risk.
The Banque de France is using one of the NGFS scenarios for a stress test that concludes in October — the second major one after a study by De Nederlandsche Bank in 2018.
Show me the money
Central banks’ supervisory sway over the whole financial system is probably the most potent way they can help society fight climate change.
But financial market specialists cannot stop eyeing the trillions of dollars central banks have printed in the past decade.
“Monetary policy and climate change is probably the last frontier,” says Després. “When we started considering it two to three years ago, it was almost unthinkable to address the topic.”
NGFS members at first saw no connection between climate change and monetary policy, and did not want to explore the issue.
Why central banks are so cautious in this area is difficult to explain, Després says: “Certainly it’s to do with the fact that central banks are very keen to respect their mandates. They have a mandate on price stability and until recently the link between climate change and price stability did not seem that obvious.”
Central banks have accepted that climate change is a risk to financial stability, but not price stability. Yet the idea that a climate-induced shock of financial instability could occur without price instability is almost absurd.
Very gradually, the conversation is moving. In June, after a lot of pushing internally, the NGFS published its first brief report on monetary policy. It covers how climate risks can affect price stability and influence how central banks set monetary policy, but does not explore how they could use monetary policy to drive the economy in a greener direction. Buried on the last page is a single sentence about this.
Eminence grise
So far, the ECB has kept a low profile on the climate. Oddly, considering that it directly supervises 114 large banks holding 82% of eurozone banking assets, it has left climate risk supervision to national central banks. It is now developing its own stress test.
Observers of the ECB say Draghi was not very supportive of the climate risk agenda — he paid lip service to it, but it was not a core part of his strategy.
However, Després says: “President Lagarde is really keen on doing something — it’s now part of the ECB strategy review.”
The ECB’s first strategy review since 2003 is due to finish in mid-2021. The discussions are confidential, but one very significant fact is clear: the review itself is about monetary policy. This means the ECB is explicitly saying climate change has a bearing on monetary policy — not just prudential policy. The dark horse of the central banking climate race is making a late surge that could put it in the lead.
What form that could take is keenly debated. The best clue comes from Isabel Schnabel, an ECB executive board member, who in September gave possibly the most forthright and determined speech by any central banker about climate change so far.
Addressing monetary policy, she went far beyond the NGFS, arguing that “collective action, by governments, firms, investors, households and central banks, including the European Central Bank, is required to accelerate the transition towards a carbon-neutral economy and correct prevailing market failures”.
Securities could be excluded from acceptable repo collateral if the issuer did not properly disclose its climate risks; the ECB could haircut more deeply securities with higher climate risks. The ECB could also reassess how it deploys its bond purchase programmes to better match a sustainable, rather than the present unsustainable, economy.
Green handouts
A proposal for greening the Targeted Longer-Term Refinancing Operation programme, put forward by Positive Money Europe and the Sustainable Finance Lab, will also be considered in the ECB’s strategy review. TLTROs are the ECB’s handouts of cheap loans to banks, to encourage them to lend.
The plan’s authors argue a green TLTRO would encourage lending to sustainable activities, instead of stimulating unsustainable ones, as ECB monetary policy does now — and that this choice is permitted under the ECB’s mandate.
Jens van ’t Klooster, one of the writers, says a green TLTRO would be “more useful than a green Asset Purchase Programme”. Whereas bonds are issued by big companies, “what is so great about a bank-based system is that it’s all small things like house refurbishments — activities that wouldn’t happen without funding.”
However, van ’t Klooster admits that although a green TLTRO would give banks an incentive to make green loans, they would not have to pass on the cost benefit to the underlying borrowers.
At the moment, such ideas still seem too politically controversial for central banks to dare. But considering how far they have already moved — and how uninhibited a few leaders such as Schnabel have become — it is more than likely green monetary policy is on its way.
Robins points out some central banks and regulators, such as the Central Bank of Brazil, Reserve Bank of Australia and US Commodity Futures Trading Commission, are “taking their independence very seriously as they address climate and environmental issues and coming forward with policies that are very robust”.
Schnabel sounds eager to get into the fray and “react pre-emptively”. But even she argues climate change “requires collective and concerted action by all stakeholders, first and foremost by legislators and national governments”.
When it comes to climate change, no central banker is going to be able to declare, as Draghi did of his eurozone measures: “Believe me, it will be enough”. Government, civil society and the private sector will have to do without a magic wand on this one.