The writer is the executive director of Fidelity International
“There have been three great inventions since early times,” American comedian Will Rogers is said to have said: “Fire, wheel and central bank.”
Rogers made his remarks about a century ago, and central banks are now having greater influence than ever before. They have evolved, like all good inventions, to remain relevant to the world in which they operate.
We are facing a climate emergency that requires collective action and central banks undergoing another transition, perhaps an annoyance, to play their part. in solving it. By reshaping asset market interventions, they can accelerate carbon emissions reductions and change in capital costs to address potential climate risks in the financial system.
Central banks have so far focused on ensuring the transition to a more sustainable and orderly and financially stable economic system, using tools such as tensions. Check the banking system for loopholes if fossil fuel assets are suddenly revalued.
These are useful exercises but can only be seen as the foundation for a more proactive stance. The large extent of physical risks associated with climate change means that central banks need to use all their powers to help the transition towards a low-carbon world. And one of their tools is speed.
Instead of waiting for governments to agree on a law, investment program or carbon tax, central banks can act now to better reflect the cost of climate change in the cost of capital and change the behavior of businesses, increase emissions costs and reduce investment costs in carbon reduction.
In terms of the financial impact, emissions are still risk-free and not costly to producers or investors – but they cause significant harm to our environment and their financial costs will incur. in other places.
This leads to a worrying disparity. Public companies are encouraged by investors and the public to get rid of their dirty assets. Some of these assets, however, run the risk of being acquired by private equity buyers with access to cheap capital, leaving society less affluent and global emissions targets not being close to being achieved.
Movements in the past, such as the 2008 global financial crisis and the euro zone crisis, have forced central banks to expand their toolkits, which can be used. to push our societies to move to net carbon emissions. To achieve this goal, there are strong policy levers that they can and should pull.
Direct monetary action, in the form of targeted asset purchases, quantitative easing programs, will reduce the cost of capital for green and innovative businesses.
Taking the case of the European Central Bank’s current QE program, this program could easily be extended to include increased green sovereign issuance as part of program purchases. .
And it could also be inclined to increase the bond allocation of green firms, creating an effective tool for subsidizing the cost of capital for eco-minded businesses. A selective independent program of corporate bond purchases, which may be related to corporate emissions, will change the behavior of issuers and investors.
Just the signal of a policy change will have a profound effect on the market. Investors will change their behavior long before any real QE purchases take place.
And separately, central banks can attack the macro security toolkit to impose additional capital requirements on emissions-contributing activity. Central banks may consider the “green” Basel framework job promotion on bank equity measures the next logical step, once they complete the fundamental work of stress testing and developing a globally consistent green investment classification.
Basel IV, which will come into effect in 2023, has a detailed system of rules to minimize the risk of a banking crisis and reduce the scope of arbitrage operations in accordance with international regulations. This powerful global tool is available immediately and can be tailored to address the ecological risks of business operations.
To address this carbon mismatch, central banks will inevitably face difficult questions about their mandate, market neutrality and lack of democratic scrutiny. But the short duration, and the severity of the climate threat, favor action more strongly than wait and see.
Central banks cannot solve this problem alone. But as Mark Carney to speak Nearly six years ago, as governor of the Bank of England: “Once climate change becomes a decisive issue for financial stability, it is probably too late.”