Channeling capital into green economy: What role can central banks play?

By Aysu Bicer

ANKARA (AA) - Climate change is no longer an "elephant in the room" issue for central banks worldwide, as some of them, realizing the need to expand their classical mandates by also backing sustainable development, began taking concrete steps to encourage green financing.

Green finance is flourishing and is now considered a game changer in handling problems facing our planet, satisfying the needs of both environmentalism and capitalism.

Working for a sustainable future, green financing is defined as any structured financial activity, product, or service that will provide better environmental outcomes.

Towards this end, central banks worldwide – perhaps best known for setting interest rates – are expected to enlarge their monetary policy toolkits for a green, sustainable future.

Many analysts argue that central banks can promote green financing by altering their regulatory frameworks.

Last year saw some such initiatives, as for example the Bank of England providing details of an upcoming climate risk stress exercise for major UK banks and insurers including a 30-year time horizon.

On the continent, the European Central Bank (ECB) also described its supervisory expectations related to the management and disclosure of climate-related risks by financial institutions.

It decided to establish a new climate change center to determine the "targets, policies and regulations" to underpin the transition to a carbon-neutral economy.

The Network of Central Banks and Supervisors for Greening the Financial System (NGFS) issued a guide to help quantify how bank lending portfolios and balance sheets react to climate risk.

In December, the US Federal Reserve – whose decisions on the dollar regularly drive financial markets worldwide – also joined the network.

- Green recovery byproduct

"This pandemic enforced concerns about climate change, and it is also not surprising that CBs have also embraced this too," said Karlygash Kuralbayeva, an economics professor at King's College London.

According to her, COVID-19 presented a golden opportunity to undertake not just a recovery but a green recovery.

"We all heard this slogan 'let's build better,' and in this case CBs will play important role in monetizing the fiscal investments undertaken by fiscal authorities. So CBs will play an important role in the recovery process of all economies,” she said.

“And if we’re talking about green, then this means they will play role in green recoveries, as a byproduct."

Kuralbayeva stressed that there are more specific ways that central banks and regulators can deal with climate change.

These include financial disclosures and climate scenario analyses to calibrate and assess the climate risks that financial sectors face, she explained, stressing there are still some challenges related to disclosures, such as the key issue of quality.

Such exercises are intended to quantify how specific bank lending portfolios and balance sheets react to drivers of physical and transition risk associated with climate change, she said.

- Central banks should add 4th policy goal: Green finance

Most central bankers and policymakers now understood that climate change is a threat to the stability of the financial system, according to Cevat Giray Aksoy, principal economist at the European Bank for Reconstruction and Development (EBRD).

According to Aksoy, central banks can use their soft power, in a low-cost and high-return exercise, to raise awareness of risks emerging from climate change and how it can potentially destroy the value of financial assets or make liabilities mount.

Secondly, he added, globally, central banks should officially add a fourth policy goal, green finance, in addition to its traditional trio of price stability, financial stability, and supporting wider economic policy objectives such as exchange rate stability.

"Such a strong signal to markets is essential, as a successful green transition is only possible if financial flows are aligned with climate change goals," he said, warning that this cannot happen without a strong formal commitment from central banks.

He also suggested that central banks should integrate environmental sustainability objectives in the management of their reserves and capital, citing as an example the Bank for International Settlements (BIS), "the central bank of central banks," which recently launched its second green bond fund for central banks to support and encourage central banks.

"Although such initiatives are promising, there’s still a lot of uncertainty about take-up," he stressed, explaining that this is mainly because the current generation of central bankers was trained to think in a macroeconomic and financial stability framework, leaving little room for other objectives.

"In the middle of the pandemic, they may also [have to] ignore the climate change threat,” he said.

"I think both financial and behavioral interventions are urgently needed for green central banking."

- Green transformation’s impact on developing countries

Guven Sak, managing director of the Economic Policy Research Foundation of Turkey (TEPAV), took a different angle on the issue.

He said green transition also has the capacity to become the new foreign policy perspective of the West, of the EU and US, warning that this could widen the already-existing technological divide between the West and “the rest.”

The European Commission and the ECB said that they want to drive a carbon-neutral economy and will encourage financing in this area, making green transformation faster and easier, he added.

But, according to Sak, this process probably may not be the same for developing countries, which have other fundamental economic issues to grapple with, such as highly indebted companies, troubled bank balance sheets, and high credit default swap (CDS).

“That is, it may take time for the green economy to take its turn in these countries,” he explained.

It seems just as an international mobilization for vaccines is underway, in the days to come the same may be necessary for green finance. And all stakeholders in the global economy should similarly be involved in efforts towards a sustainable and fairer future for everyone.