As wildfires in California resulted in almost 40,000 acres burning and tens of thousands of buildings being destroyed, the backslide in global climate politics brazenly continues. Many jurisdictions around the world are battling against the economic impact of intensifying nature catastrophes and extreme weather events, at the same time, climate inaction and sluggish action plague governments. Most recently, the Federal Reserve announced its resignation from the Network for Greening the Financial System (NGFS), a worldwide cooperation of central banks and financial supervisors. Under the auspices of the NGFS, central banks have been working on understanding what the impact of climate inaction looks like for economies all around the world —and more increasingly specifically in the Global South— and how they can enable climate action for financial world and government agencies. In light of Fed’s withdrawal, it is important- now more than ever- to understand what kind of weight global climate cooperation efforts can have in the greening of the financial system.
The NGFS, founded in 2017 at the Paris “One Planet Summit” is tasked with exploring what climate change means for central banks, financial regulators, and monetary supervisors (hereon “central banks”). The Network, with now over 140 members, representing more than 80% of the world economy provides a forum to address collectively the effects of climate change on the financial markets, the so-called climate and nature-related financial risks (CNFR). The NGFS is a “coalition of the willing”, meaning members of the organization are not legally bound by its decisions as in an international treaty organization. Currently, it is the only international organization in the world that brings together so many central banks with the aim of greening the global financial system. It is therefore legitimate to ask how they can serve the interests of societies and ecosystems and promote a green and just transition.
A coalition of the willing
Despite having the wind of the Paris Agreement at their backs, the founding members of the NGFS, with players such as the Bank of England, Banque de France, and Bundesbank on the roster, did not gain the initial support of the Federal Reserve (“The Fed”). This was no coincidence. The NGFS was founded as an alternative to the obstructive efforts of the US and Saudi Arabia at the G20 Green Finance Study Group, which was initially set up in 2016 by the People’s Bank of China (PBoC) and the Bank of England (BoE) to align global finance with the Paris Agreement goals. The Fed only joined after the start of the Biden presidency, as part of a broader agenda shift towards green policies in the US. The lack of US leadership coincided with France’s ambitions in leading the global climate politics agenda. The political clout of Emmanuele Macron (who called the One Planet Summit in 2017 into action) also resulted in the NGFS Secretariat being based inside the Banque de France, in Paris. The French leadership has been decisive for developing the agenda of the NGFS, along with the European Central Bank, ECB.
Doing green central banking?
By now, central banks are well aware that the effects of climate crisis and environmental degradation have to be factored into financial transactions. Both the repricing of financial assets due to extreme weather conditions like extreme heat and floods (so-called physical risks) and the costs of transition to a low-carbon economy for the holders of carbon-intensive “brown” assets (transition risks) already have considerable effects on financial markets. The NGFS has acknowledged these risks as financial risks from the start, thus strategically putting them within the scope of central bank mandates. Its 2019 First Comprehensive Report “A Call for Action” puts together a set of recommendations for central banks. These six recommendations address elementary issues like identifying and assessing climate and nature risks, but also contentious and untrodden ground such as implementing green monetary policy and integrating sustainability criteria into central banks’ portfolio management. While the beginnings of the Network show humble aspirations such as promoting best practices among central banks and generating knowledge on climate analytics, under the current leadership of Sabine Mauderer from the German Bundesbank, the demands on members to implement the NGFS recommendations are being increasingly more pronounced.
A risk-based approach
In the past five years since the publication of its 2019 First Comprehensive Report, the NGFS has set up working groups for each recommendation, which are tasked with fleshing out a roadmap. The most remarkable output of the NGFS is its climate scenarios, which are either widely adapted by other central banks or used as a point of reference for financial institutions. These predict the long-term trajectory of climate risks and their implications on the economy and are part of a “risk-based approach” that NGFS promotes in its publications. The NGFS climate scenarios are part of an overarching objective of “closing the data gap”. The underlying argument is that central banks need to understand, identify, and measure climate and nature risks before taking policy action. Accordingly, central banks’ priority should be to overcome data availability and quality issues in the identification and assessment of CNFR, which pose a hurdle for all climate-related risk metrics that eventually feed into green monetary policy frameworks.
On the other hand, the NGFS has shown little effort in actively promoting green monetary policies. For example, alternatives such as integrating climate aspects into existing macroprudential regulatory frameworks (for example systemic risk buffers) are not included in their recommendations. Similarly, capital mobilization necessary for a green transition through targeted green lending operations, already implemented by some central banks like the PBoC, are not part of the NGFS recommendations. Generally, the NGFS shies away from a promotional approach that requires central banks to rethink their approach to markets and target green industries over carbon-intensive financial assets.
Since 2020, the NGFS has published eight policy reports (so-called Technical Documents) explicitly focusing on greening monetary policy, two of which are surveys conducted with NGFS members, and the March 2021 report decidedly refrains from giving recommendations. Despite being quite outspoken about the impact of the climate emergency and natural disasters on the operational frameworks of central banks (“calling for concrete action”), the takeaways are relatively modest in terms of proactive policy suggestions: exploring avenues for better communication and sharing best practices, pushing for mandatory climate risk disclosures by financial institutions, and improving climate metrics. As such, the risk-based approach tacks on climate concerns in existing market-based finance logics and cannot account for the long-term uncertainty brought on by climate change.
This raises questions regarding the NGFS’ ambitions of shaping the transition plans of central banks around the globe. Regulatory tasks of central banks are generally left out as a potential lever against mitigating CNFR in the NGFS recommendations, despite the fact that many are either considered or are already in use by member organizations within the NGFS. Considering that greening monetary and macroprudential policy frameworks are important conduits of green transition frameworks, it is surprising that the NGFS is not more vocal on green monetary policy in its publications.
Against the backdrop of intensifying effects of the climate crisis, central banks cannot buy time to perfect their climate analytics and models. Climate mitigation measures can take place before having all the information at hand. Central banks can focus on the most obvious climate-risky assets and financial institutions with the most exposure to risky assets and tilt their balance sheets away from them, for example. One decisive step towards regulation of climate risk can have spillover effects in other monetary jurisdictions, potentially countering the effects of the climate crisis. This proactive approach has already some proponents in academia. Important voices within the NGFS like Sylvie Goulard or the former NGFS Chair Frank Elderson similarly argue for a more active approach by central banks.
Roadblocks
The reluctancy of the NGFS to be more outspoken on central banks’ green monetary and regulatory tools might have something to do with the institutional and (geo)political mélange of central banking. Some argue that the reason why the NGFS focused on other measures like greening their own portfolios and was generally holding back on monetary policy options was because of the contentious nature of the latter. A risk-based framing of climate change allows central banks to integrate climate issues into their existing policy paradigm without risking a mandate breach. This also explains why there was initially no NGFS Workstream on monetary policy.
A second and complementary factor is the organizational heterogeneity of the Network. The cleavage between the Global North and South is already visible in policy choices: Central banks in the Global South like in Philippines, China, and Singapore take active steps to bring about green transformation: promoting green lending via targeted refinancing programs (Bangladesh Bank), launching lending facilities with preferential rates for green projects (Bank of Japan and PBoC), which are not matched in effect by the ECB’s de-carbonization plans. The NGFS, in a sense, reflects this divergence by settling for the lowest common denominator: focusing on mainstreaming disclosure standards and improving their climate analytics. While it is commendable that the NGFS is not suggesting a “one size fits all” approach for central banks worldwide, it can propose monetary policy options that reflect the diversity of its members and a higher responsibility of advanced economies in contributing to climate justice.
A way forward
What can the NGFS do in order to effectively guide central banks to a green and just transition? A concrete solution in the short-term would be to opt for a more sticks, fewer carrots approach: Policy debates by NGOs like Greenpeace, Climate Bonds Initiative, Reclaim Finance, Positive Money, or from academic experts, offer various instruments that combine incentivizing measures with sanctioning elements of monetary policy that central banks have in their toolbox. Specific examples include credit guidance, greening capital requirements for banks and collateral frameworks, dual interest rates to encourage lending on green investments (green TLTROs). These powerful measures can be put on the agenda of the NGFS as policy recommendations. Green TLTROs were notably endorsed by Emmanuel Macron at the Dubai COP28 meeting in December 2023.
However, in the long run, we need a fundamental shift in green central banking that moves away from risk-oriented thinking. A risk-exposure based approach that frames climate change as a financial risk issue, while being an important step in the right direction, does not challenge the current policy paradigm. Quantification of the impact of climate crisis and environmental degradation as a risk is not always possible due to the radical uncertainty surrounding it, however, central banks still can and should contribute to decarbonization efforts at a global scale. Policy solutions exclusively focusing on climate-risk disclosures and climate stress tests will prevent central banks from delivering their commitments on green transition. Amid backsliding climate politics and green transition efforts, the NGFS needs to get bolder as a “coalition of the commited” and step up to the plate.
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