Why central banks are pivotal to the climate transition

As Climate Week NYC 2024 kicks off in a flurry of activity and triggers important dialogue around the role of finance in transitions, I wanted to reflect on a conversation we hosted before the summer, focused on the role of central banks in addressing climate change.

Central banks are a key actor in Laudes Foundation’s Finance and Capital Markets programme strategy. Not only do they oversee the banking sector, a crucial source of funds for business, but they also play a vital role in maintaining financial stability within the economy. In both roles, central banks are pivotal to the transition. The transition will require significant investment and, if not abated, presents unparalelled risks to the stability of economies globally.

Our session set out to better understand how central banks can play a multifaceted role in navigating the economy to a safe and equitable future.

The conversation included Jean Boissinot, former Deputy Director, Financial Stability, Bank of France, and former Head of Secretariat, Network for Greening the Financial System (NGFS), and Alexander Barkawi, Founder and Director, Council on Economic Policies (CEP). Cedric Pacheco, Senior Programme Manager in our Finance and Capital Markets Programme team, expertly facilitated the session.

Here are key takeouts from a very rich discussion which centred around the question “Should central banks be more proactive on climate?”.

Climate transition aligns with central banks’ primary mandate

“The fact that the financial risks from climate change and environmental degradation are part of central banks’ remit is uncontested. What is more contested is whether central banks should go beyond that and take a more proactive role in support of climate and environmental objectives.” - Alexander Barkawi

Central banks have come a long way in acknowledging the climate challenge over the last ten years. However, as asset owners, climate change poses risks to central banks’ balance sheets – their assets could lose significant value. Both types of climate risk – transition risk and physical risk – have a material impact on the risk profile of the central banks’ balance sheets. In addition, financial supervisors, including central banks, must ensure commercial banks also consider these risks.

Jean Boissinot agreed that “climate change is not a policy option but is a scientific fact.” He described the European Central Bank (ECB) agreement that climate action supports its primary mandate as “game-changing…central banks cannot turn a blind eye to climate change and the transition as it is part of their common mandate”.

Diagnosis versus action

Both panellists highlighted recent central bank actions on climate, praising the European Central Bank’s move to integrate climate considerations into asset purchasing decisions and supervisory expectations that commercial banks factor in climate risks – an outcome that work by Council on Economic Policies (CEP) and other Laudes partners contributed to.

Jean stated, "There has been a complete transformation of how European banks look at such risks, something that I would not have expected would happen so quickly.”

While Alexander agreed that these changes have been faster than expected, he also cautioned that central bank action in this area is still too slow. He highlighted a huge gap between “diagnosis and action” as central banks tend to gather evidence and build scenarios while the need for action is growing.

Alexander warned that the gap between diagnosis and action is even starker when considering the broader environmental crisis, “When it comes to Nature, we’re just building scenarios. We’re diagnosing, but we’re not taking action fast enough.” 

Discussions on social aspects of the transition and inclusivity have been even less progressive. Alexander offered an example of where green measures introduced by central banks can negatively affect financial inclusion, such as when small businesses are unable to provide required green disclosures to qualify for loans.

Jean defended the need for robust modelling to mitigate the possible impacts of the climate transition on workers and communities.

He explained “central bankers think about the difference between intent and impact. The intent is to deliver on the mandates that society has given. Sometimes, there are impacts when doing so. These can be very positive impacts, things we are happy to have happen, but the more negative impacts must be managed. It's important to recognise that when we discuss climate, we should never lose sight of the priority to deliver on monetary and financial stability.”

A lever for systems change, but not the silver bullet

The climate and environmental transition path is technical and complex. While central banks can be an important lever for system change, they can’t be the silver bullet that solves everything.

At Laudes Foundation, we believe central banks are key to driving finance toward a just transition. But, as our panellists pointed out, considerations about environmental tipping points, inequality, and inclusion must be integrated into discussions and policies.

Central banks are first and foremost here to deliver financial and monetary stability. It is increasingly apparent that this cannot be achieved while turning a blind eye to the disruptive force of climate change and its associated human impacts.