Green Swans’ A’Swimming: Central Banks Counter Climate-Change Risk
January 23, 2020
On Monday, the global central bank released a lengthy report urging central banks to take a direct role encouraging, mandating, and even creating a market for green finance. This echoes actions taken outside the U.S., along with many calls by global leaders this week at Davos. Green finance via central banks does not, however, come cheap in terms of central-bank independence, monetary-policy effectiveness, market integrity, or safety-and-soundness standards.
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In a new FedFin report, we analyze the Bank for International Settlements’ sweeping call for central-bank action to prevent what it dubs “green swans” – systemic risks resulting from sudden climate events. The lengthy BIS paper echoes work well under way in the European Union, Canada, China, and many other nations but not the U.S. Although Democrats are demanding not just a “green new deal,” but also climate stress-testing, the FRB has so far refused to do more than reiterate the need for banks to manage credit risk due to weather or similar hazards.
The BIS demands far more from the Fed and other central banks even as it worries that some of what it wants might have perverse consequences on central-bank independence, regulatory integrity, and the more conventional and direct route to energy policy set by fiscal authorities. Key take-aways from the BIS report include:
- a demand for quick action on bank climate stress tests. These should focus on near-term risk even though the BIS readily acknowledges that quantifying it and then changing financial policy to mitigate it poses an array of methodological and policy challenges;
- the likelihood of central-bank purchases of green bonds along with allowing them as eligible collateral. The BIS believes current policy exacerbates climate risk, urging a “greening” of central-bank holdings to ensure “market neutrality” even as it notes that green bonds pose an array of impact and definitional challenges that could put central banks at risk;
- capital charges to penalize “brown” exposures even though this may neither reduce risk nor prove a meaningful stimulant to green finance; and
- central-bank work with fiscal authorities to determine the sovereign-risk implications of applying modern monetary theory to massive taxpayer purchases of green bonds. The BIS thinks sustainable debt may well be far less risky than household or other corporate obligations. The BIS also believes that ultra-low rates make it less risky for nations to increase their debt loads beyond the levels at which central banks long thought fiscal risk was sure to follow.
Each of these central-bank policies has far-reaching impact on banks, financial markets, monetary policy, and even government action to contain climate risk. None of them will happen in the U.S. unless or until the 2020 election redirects America’s climate-change policy. However, regardless of U.S. politics, near-term global action to implement BIS recommendations or go beyond them could make a meaningful climate difference, but also reconstruct central-bank portfolios, alter the role of the dollar, crowd out other assets on bank balance sheets, and heighten financial-industry political risk. This is an especially acute concern in the U.S. given recent demands for an order from President Trump barring “politicized” lending.
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