Two motorised paragliders circled the European Central Bank’s headquarters earlier this year, before landing on it to unfurl a bright yellow Greenpeace banner declaring “Stop funding climate killers”. The message for the region’s monetary policy chiefs was clear.
The specific target of the protesters was the more than €300bn of bonds issued by fossil fuel companies that they said the ECB had accepted as security for its cheap loans to banks. The campaigners called on the central bank to stop accepting these “dirty bonds” as collateral or to drastically reduce the amount it lends against them.
Even before the airborne activists appeared on the Frankfurt skyline, most major central banks had already realised that they needed to do much more to address growing public concern about the environment. Although ECB president Christine Lagarde chided the protesters for “exposing people’s health [and] life possibly”, she also said climate change was “the biggest challenge that is addressed to us”.
The issue will gain more prominence on Wednesday when many of the world’s top central bankers, including Jay Powell at the US Federal Reserve, Yi Gang at the People’s Bank of China and Lagarde herself, will speak at the “Green Swan” virtual conference on how to tackle climate risks in finance.
The event, held by the Bank for International Settlements, the Banque de France, the IMF and a club of 90 central banks and watchdogs called the Network for Greening the Financial System, underscores how climate change has shot up the central banking agenda.
The ECB has made global warming a key part of its strategy review that is due to conclude in September, while the Bank of England has taken on a new mandate to make its monetary policy greener and the US Federal Reserve recently joined the NGFS. Even the People’s Bank of China has said it will consider including climate risks into its annual stress test of the country’s banks.
But despite this frenzy of activity, it remains far from clear what exactly central banks will do to tackle climate change. While much of the debate has focused on the potential greening of monetary policy, there are considerable obstacles to this. The area where there is likely to be much swifter and more concrete action is banking supervision.
The NGFS recently proposed nine ways central banks could make monetary policy greener, such as environmentally targeted asset purchases or lending schemes. However, it acknowledged that all of them “have to overcome a range of practical and analytical challenges, including data gaps and uncertainties with regard to risk quantification”.
There are also worries about “mission creep” at central banks that could distract them from their main inflation target. If a central bank starts buying greener assets, only to stop once inflation rises, will it then be attacked for failing to protect the environment?
“Climate change is important for financial stability issues,” says Kristin Forbes, a professor at the MIT Sloan School of Management and former member of the Bank of England’s monetary policy committee. “But . . . I worry that central banks just don’t have effective tools and there is already far too much on their plate. I would rather they stick to their knitting.”
A more promising avenue for central banks is through their role as banking supervisors. This year, the BoE is running the first-of-its-kind climate stress test to assess the risks of everything from extreme weather events to the demise of traditional fossil fuel-powered energy and industrial companies.
The ECB plans to conduct a similar exercise next year and eurozone banks are already under the spotlight after the central bank published a guide on how it expects them to address climate risks and asked them to submit action plans to achieve it. Those falling short can expect higher capital requirements.
“Banks have a key role to play,” Frank Elderson, vice-president of supervision at the ECB and chair of the NGFS, said on a recent podcast. “If needed we can use the entire box of tools that we have to make sure they become compliant [with our expectations]. It will be a journey. This is the first year. As of next year and beyond, our reaction will become more forceful.”
This steadily intensifying pressure is starting to register at European banks. Deutsche Bank chief executive Christian Sewing said recently that lenders “risk losing their licence to operate” if they do not make green finance a priority.