Can central banks save the planet?
The global guardians of financial stability are now being challenged to use their influence to save the environment, writes Tom Rees
On a drizzly day last October, the usual traffic of red buses and sharp-suited City workers around the Bank of England was conspicuous by its absence. The crossroads outside the bank had been brought to a standstill by eco-activists brandishing umbrellas and cutouts of governor Mark Carney’s head.
The Bank of England’s policymakers, the controllers of inflation and safeguards of financial stability, may seem peculiar targets for the Extinction Rebellion protests that now frequently grip London.
But after single-handedly dragging the global economy out of the Great Recession, central banks could next be tasked with tackling the climate crisis.
Eco-activists have called on the Bank of England and the European Central Bank (ECB) to ramp up the pressure on the financial industry and even use monetary policy to aid the transition to a zero-carbon economy.
They want central banks to help the booming market for green bonds — debt issued to fund climate and environmental projects — and clamp down on the investment mammoths standing in the way of change. Some policymakers, such as Christine Lagarde, the new ECB president, have pledged to step up to the challenge.
But some economists fear that transforming the goals of central banks risks destroying their credibility, and could create a dangerous green asset bubble that would ultimately harm the environmental cause.
However, advocates say central banks’ place at the heart of our financial system could give them a starring role in the fight against climate change.
Banks need to be “an essential actor” and should push markets to focus on the goal set out in the 2016 Paris Agreement of keeping increases in global temperature well below 2C, says David Clarke, head of policy at Positive Money, a pressure group seeking reform in finance.
“Although governments must lead by adjusting regulation, taxes, subsidies and public investment, they will not be successful unless financial flows are urgently reorientated,” he says.
Such an objective would go well beyond the current remit of central banks to maintain stable inflation. It could require such major economic intervention that some campaigners have been accused of using the environment as a front to demand hard-left policies.
But some central bankers are open to activists’ ideas, and Lagarde is seen as particularly receptive.
Lagarde has even suggested that the ECB could use its quantitative easing (QE) programme to lower the cost of green bonds.
Eco-activists want central banks to focus on buying green bonds or to shun debt issued by high-carbon companies, making it more costly for the likes of miners and oil firms to finance projects. Some believe the ECB could also put a green tint on its targeted long-term refinancing operations — a programme of cheap long-term loans provided to banks. Institutions classed as “green” could be granted access to cheaper finance.
But central banks ultimately get their remits and mandates from politicians.
Although green bonds have enjoyed explosive growth over the past decade, they are still only a fraction of the bond market, which is estimated to be worth more than US$100 trillion. Almost US$240 billion of green bonds were issued in a record year in 2019, a 20,000 per cent surge in a decade, according to Environmental Finance.
One key challenge is that the green bond market could be too small to target for policymakers.
“The ECB is probably aware of the fact that the amount of green bonds they can buy for their QE programme is limited and we think they will take this in consideration,” says Bram Bos, a green bonds fund manager at NN Investment Partners, the Netherlands’ biggest life insurer.
That challenge is likely to eventually be met by already-strong demand for green investment products. More companies are tapping the booming green bond market to fund sustainable investments, including tech giant Apple, which raised €2b in November to develop more energy-efficient and recyclable products.
Plans to widen the remit of central banks to include snapping up green bonds have faced a backlash from economists and ratesetters, such as Jens Weidmann, the Bundesbank president. Jorg Kramer, Commerzbank chief economist, warns that central bank credibility is at stake if policymakers bow to pressure from ecoactivists.
“If the ECB gives a signal then the [green bond] market will explode and then we have the issue of a target conflict,” he says. If the ECB tightened policy by winding down QE, that would hit the green asset market, potentially disappointing the public.
But if the ECB ignores its traditional inflation target and continues to buy green assets, it would risk “inflation going up, asset price inflation or even bubbles”.
Green QE would foster the clean energy market by reducing the financing costs of environmental projects, but this would have little impact on the actions of more polluting industries.
Kramer says green QE is therefore an inefficient way of reducing emissions compared to carbon pricing, which makes the cost of emitting more expensive through trading schemes or a carbon tax.
Even Bank of England governor Mark Carney, who will soon become the UN’s special envoy for climate change, has opposed the idea. He said demands for ratesetters to use tools like green QE to solve the climate crisis “should be resisted”.
The bank has steered away from using monetary policy tools, instead focusing its climate change strategy on safeguarding financial stability.
It has repeatedly warned there could be “stranded assets” that become worthless because of climate change, urging the financial industry to prepare for the transition.
It will become the first central bank to stress test its financial system against the threat of climate change. By mid-2021 the Bank will reveal the system-wide threat posed by climate change scenarios but will not name and shame firms.
However, the Daily Telegraph understands the bank could issue penalties to companies that fail to prepare in later stress tests.
Although the stress tests are a “valuable tool”, the “more light they can shed on individual firms the more impact we would expect them to have”, says Clarke, of Positive Money.
He believes the bank needs to step up its action to put the City on the “right path”.
Next week central bankers will jet into Davos. This year’s theme — Stakeholders for a Cohesive and Sustainable World — aims to tackle the climate crisis dawning on investors.
Egged on by protesters, their eyes will be on the likes of Carney, Lagarde and the world’s top rate-setters for guidance as politicians fail to make headway.
After single-handedly dragging the global economy out of the Great Recession, central banks could next be tasked with tackling the climate crisis.