Principled principals
Central banks should go further and faster on climate change
During the 27th Conference of the Parties to the United Nations Framework Convention on Climate Change and the G20 summit, world leaders agreed that the global financial system requires a "transformation" to achieve the trillions of dollars of green investment needed to mitigate climate-related risks. Central banks will have to play a key role in this transformation. They are ultimately responsible for the stability of the financial system, which is increasingly exposed to climate change. To meet these needs, central banks need to ensure that climate risks are not undermining economic stability and, where possible, provide incentives to accelerate the development of low-carbon finance.
At this time, with global economic and policy uncertainty, central banks, including the People's Bank of China, are fighting many fires at once, with prices of food, energy, and other commodities rising rapidly, while economic growth is slow. But while limiting inflation and short-term risks to growth, financial policymakers must not lose sight of the long term material risks of climate change and their impacts on the financial sector and the wider economy. From wildfires, to floods, to droughts, the impacts of climate change are already causing devastating human suffering and economic destruction across the globe. China has experienced its hottest summer on record with severe risks to the energy system and agricultural production. These events should be enough to convince central banks and financial regulators that supporting the net-zero transition is a central pillar of their core mandates for price and financial stability.
A new report by Positive Money UK suggests that the central banks of the world's major economies have space to act much more decisively and learn faster from each other. The good news is that in the updated ranking of the G20 central banks and supervisors, the researchers found that climate considerations have become increasingly mainstream among central banks. Seventeen out of the 20 countries have achieved full marks in the research and advocacy category which assess speeches, conferences and reports. Both the Banque de France (this year's score card winner) and the Financial Research Institute of the PBOC have published advanced research indicating that the financial sector is contributing to environmental damage, in addition to being at risk from the consequences of the climate crisis.
Some central banks have also made progress by providing incentives for accelerating green investments and unlocking capital for green economic growth. This is especially important in the context of increasing interest rates, which risks choking off much needed capital investment in green infrastructure such as the energy sector transformation. Central banks can further innovate and update their monetary policy tool kits. For instance, they should move more quickly and impactfully to subsidize green lending through a discounted interest rate. The PBOC has provided such an instrument through its carbon emissions reduction facility, announced in 2021. The carbon emissions reduction facility aims to promote carbon reduction and support the development of clean energy and energy conservation. This instrument allows financial institutions to provide loans to borrowers, 60 percent of which will be refinanced at 1.75 percent, less than half of the benchmark Loan Prime Rate. By the end of September 2022, around $35 billion equivalent (240 billion yuan) worth of the carbon reduction credit facility had been used and had financed carbon cuts of more than 80 million tons. Innovations such as these have allowed the PBOC to improve its total green score to 53 points compared to 50 in 2021.
Alongside promoting green investment, central banks must also face the other side of the coin and wind down the financing of fossil fuels and other polluting industries. One reason the PBOC dropped three places from 3rd to sixth this year was its expanded support for coal-related projects. In the aftermath of the electricity outages in 2021, the PBOC reportedly installed a 200 billion yuan ($31 billion) relending program for "clean coal". In April 2022, the PBOC provided 890 million yuan of note financing support for 10 thermal power enterprises in the first batch, and in May 2022, a second batch was announced worth 100 billion yuan "to support the clean and efficient use of coal".
As various central banks have been able to significantly improve their green policies and products, international cooperation and knowledge-sharing is crucial. Efforts to decarbonize central banks' own asset purchasing schemes have benefited from cross-border dialogue. The European Central Bank has taken a leading role in this area, by tilting its own portfolio of corporate bonds toward companies with a better climate performance, as well as penalizing carbon intensive assets in the collateral that can be pledged by financial institutions to borrow central bank money.
However, as the risks of climate change continue to materialize, the study highlights that central banks and financial regulators must act much more decisively to mitigate further financial crises and climate breakdown. No central bank in the G20 countries is currently on the path to sufficiently reduce the private sector's financing of fossil fuels to align with the Paris Agreement goal of limiting global warming to less than 2 C above the pre-industrial level. Many central banks continue to have insufficient data standards, weak risk management policies and insufficient incentives for the financial sector to provide low-cost lending to low-carbon products.
The study also highlights further opportunities for central banks to support net zero, including requirements for banks to hold extra capital to price in the risks associated with fossil fuel lending, consideration of limits on lending to the most environmentally destructive activities, and active supervision of financial institutions' transitions to net zero.
With the need to rapidly reduce finance for polluting activities and scale finance for green investments, it is promising that central banks are expanding their work. However, as global emissions keep rising, more decisive work will be required to shift financial flows to a credible pathway to net zero, and stop allowing financial institutions to lock in long-term environmental risks that jeopardize financial, economic, ecological and ultimately social stability.
Nikki Eames, who worked in the United Kingdom Parliament helping to prepare Commonwealth Parliamentarians for COP 26, is a researcher at Positive Money. Christoph Nedopil Wang is the director of the Green Finance & Development Center at Fanhai International School of Finance at Fudan University and an associate professor of Practice at Fudan University. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.
Contact the editor at editor@chinawatch.cn.
