Blog Post

Green central banking

A few weeks ago, Silvia Merler discussed the rise of “ethical investing”. A related question emerging from the discussion is whether central banks should also “go green”. Silvia reviews the latest developments and opinions on this topic.

By: Date: December 3, 2018 Topic: Energy & Climate

A UN report published last year looked in detail at the role of central banks in enhancing green finance. Given the enormous investments needed to bring about a green transformation, the financial sector will have to play a central role in allocating resources towards a sustainable and green economy, and stop financing activities that harm the environment.

The paper examines the extent to which environmental factors impinge on central banks’ conventional goals and provides a theoretical analysis of the cases for and against central banks responding to environmental and sustainability challenges. It also explores ways in which central banks and financial regulatory authorities can impact both investment decisions and creation and allocation of credit through policies that support the goal of “greening” financial systems. While making the case for a proactive, “sustainable development role” of central banks, the paper also discusses the risks of overstretching mandates.

Emanuele Campiglio and his co-authors look at similar issues. The role of central banks and financial regulators in re-directing finance towards low-carbon investments by means of their policy tools, e.g. via bank lending, has been highly controversial. Their monetary and macroprudential policy tools could prove effective in managing a potential “carbon bubble” before it creates systemic effects. However, these institutions will be eager to do more to encourage lending towards low-carbon investments only if they perceive their mandate to allow them to do so. Whether such a mandate is appropriate requires further examination, according to the authors, for two reasons. First, because there is a risk of overburdening central banks and financial regulators with an excessively wide range of responsibilities. And second, because as unelected institutions, it may be undesirable to entrust too much power to them without the proper democratic checks and balances, especially as this would leave these institutions vulnerable to lobbying by special interests.

Simon Dikau and Ulrich Volz have a paper out at the Asian Development Bank Institute, arguing that responsibility for financial and macroeconomic stability lies implicitly or explicitly with the central bank, which therefore ought to address climate-related and other environmental risks on a systemic level. Furthermore, central banks, through their regulatory supervision over money, credit, and the financial system, are in a position to support the development of green finance and enforce an adequate pricing of environmental and carbon risk by financial institutions.

Dikau and Volz distinguish five different policy areas where they believe Central Bank could “go green”, i.e. (i) micro-prudential regulation (e.g. by requiring banks and other financial institutions to adopt Environmental & Social risk-management standards, to assess and disclose climate-related risks, or to adjust reserve holdings); (ii) macroprudential regulation (such as the Central Bank of Brazil introduced in 2011); (iii) financial market development (by participating in the creation of an enabling environment for the issuance and trading of green securities); (iv) credit allocation, and (v) central bank soft power and guidelines.

Sini Matikainen and co-authors look at the climate impact of quantitative easing (QE), arguing that central banks should consider how their operation of monetary policy could affect the transition to a low-carbon economy. The reason behind this is that even supposedly market-neutral interventions by central banks may show an unintended structural bias towards carbon-intensive industry incumbents. A sectoral analysis of the QE corporate bond purchase programmes of the European Central Bank (ECB) and the Bank of England (BoE) suggests a skew towards high-carbon sectors – e.g. it is estimated that utilities, the most carbon-intensive sector by emissions, make up the largest share of purchases for both banks. The purchase of such assets – the authors argue – is in direct contradiction with, and may undermine, the signals that financial regulators are making about the risks associated with high-carbon investments. The recommendation is for both central banks to increase transparency around the purchases and selection process, investigate the impact of their interventions on both high-carbon and low-carbon investment, and consider options for changing their purchasing strategies by revising eligibility criteria and using monetary policy more effectively to support long-term sustainable growth.

Irene Monasterolo and Marco Raberto develop a stock-flows consistent, flow-of-funds behavioural model to simulate three scenarios, i.e. an unconditioned QE, a green QE conditional to the purchase of green sovereign bonds, and conventional monetary policies. For each scenario, they analyse the impact on green investments and jobs, credit conditions, green/brown bonds market, and inequality across heterogeneous households and sectors, identifying main feedback loops and transmission channels. They find that  green QE promotes faster development of the green bonds’ market, with positive spillovers on green investments, employment, commercial and central banks’ reserves, and on decreasing risk of stranded assets for the financial system. However, in all scenarios they find that wealth concentration in the credit sector and in the wealthiest household increases, with undesirable effects on income inequality, financial stability and aggregate demand.

Thomas Hale at FT Alphaville points to a speech by Benoît Cœuré, member of the ECB’s executive board, according to whom the ECB owns a quarter of the eligible universe for green public sector bonds, which totals €48 billion. For green corporate bonds, the proportion is one-fifth. These holdings mirror the ECB’s ownership across bonds markets, and it has followed principles of “market neutrality”, meaning the bonds were not bought to deliberately boost the green financial market, even if the purchases had that effect. Hale notices that central banks’ engagement with green finance has the capacity to transform the financial system from one which targets a certain level of inflation to one which also targets a certain kind of environment.

The starting point is whether the environment falls under the central bank’s mandate. EU treaties are not conclusive on the topic, as the primary objective of the ECB is to maintain price stability, and secondarily to “support the general economic policies of the Union”. Hale notices that important questions in this area are whether the ECB should be involved in determining the way for market to “price climate risks properly” – thus effectively introducing a green element to its collateral framework – as well as whether the European Commission could or should adjust capital requirements for green assets.

Mark Carney highlighted in a recent speech how the risks posed by climate change are currently most directly relevant to the BoE’s microprudential responsibilities for the safety and soundness of the banking and insurance sectors. The aim is to establish whether insurers and banks have adequate governance arrangements to develop strategies for identifying and mitigating climate risk over sufficiently long time horizons across their entire businesses, both the assets and liabilities. But the Bank has also been working on assessing risks across the system as a whole, e.g. by routinely including weather-related shocks in the scenarios for its biennial general insurance stress test, including three North American hurricanes in 2017. However, non-profit organisations such as Positive Money argue that the Bank of England should go further. Also the People’s Bank of China (PBoC) has very recently decided to start allowing green bonds as collateral for its medium-term lending facility.

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article Download PDF More on this topic

Policy Contribution

The euro as an international currency

Is a more important international role for the euro worth pursuing? What measures would achieve this result, if it is worth pursuing?

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 18, 2018
Read article More on this topic More by this author

Blog Post

Brexit: Now for something completely different?

The life of Brexit. After a week of ECJ rulings, delayed votes, Theresa May’s errands across Europe and the vote of no confidence, we review the latest economists’ opinions to try to make sense of what has changed and what hasn’t.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: December 17, 2018
Read article More on this topic

Blog Post

Does the Eurogroup's reform of the ESM toolkit represent real progress?

The deal reached on euro-zone reform at the December 4th Eurogroup is not ground-breaking. However, it contains a number of incremental but potentially key technical reforms – in particular regarding the ESM toolkit. Some constitute an improvement, but there are also clear flaws that should be corrected at the Euro Summit.

By: Grégory Claeys and Antoine Mathieu Collin Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article Download PDF More on this topic More by this author

Policy Contribution

Forecast errors and monetary policy normalisation in the euro area

What did we learn from the recent monetary policy normalisation experiences of Sweden, the United States and the United Kingdom? Zsolt Darvas consider the lessons and analyse the European Central Bank’s forecasting track record and possible factors that might explain the forecast errors.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article More on this topic More by this author



Deep Focus: Consequences of European Central Bank forecasting errors

Bruegel senior scholar Zsolt Darvas speaks about his review of systematic errors in ECB forecasting, in another instalment of the Deep Focus podcast on 'The Sound of Economics' channel

By: The Sound of Economics Date: December 12, 2018
Read article More by this author

Blog Post

Les gilets jaunes

For weeks, protesters wearing yellow motorist vests have taken to the streets of Paris to protest against the rising price of fuel. They have since taken on a wider role, and are seen as symbols of the growing popular discontent with President Macron. Silvia Merler reviews scholars’ opinions about this movement.

By: Silvia Merler Topic: Energy & Climate, European Macroeconomics & Governance Date: December 10, 2018
Read article More on this topic

Blog Post

Providing funding in resolution: Unfinished business even after Eurogroup agreement on EMU reform

The recent Eurogroup agreement on euro-area reform foresees a greater role for the European Stability Mechanism (ESM) as a backstop to the banking union. This is a welcome step forward but important issues remain. We assess the agreement on how to fund banks after resolution and the best way to organise the fiscal role in liquidity provisioning to banks. We argue that the bank resolution framework will remain incomplete and its gaps could result in important financial instabilities.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: December 7, 2018
Read article More on this topic More by this author

Blog Post

ECB’s huge forecasting errors undermine credibility of current forecasts

In the past five years ECB forecasts have proven to be systematically incorrect: core inflation remained broadly stable at 1% despite the stubbornly predicted increase, while the unemployment rate fell faster than predicted. Such forecast errors, which are also inconsistent with each other, raise serious doubts about the reliability of the ECB’s current forecast of accelerating core inflation and necessitates a reflection on the inflation aim of the ECB.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 6, 2018
Read article More on this topic

Blog Post

The international role of the euro

The authors assess whether the euro area should pursue a greater international role for the euro, as outlined by European Commission president Jean-Claude Juncker, and how it might go about doing so.

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 3, 2018
Read article More by this author



Backstage: Transitioning towards sustainable finance

In this episode of the Backstage series, Bruegel's Non-Resident Fellow Dirk Schoenmaker welcomes Molly Scott Cato, a Green party MEP for South West England, for a conversation on the EU's plan to transition towards sustainable finance.

By: The Sound of Economics Topic: Energy & Climate, Finance & Financial Regulation Date: November 30, 2018
Read article More on this topic


What the "gilets jaunes" movement tells us about environment and climate policies

Simone Tagliapietra and Georg Zachmann write on the climate governance lesson European governments should learn from the "gilets jaunes" experience.

By: Simone Tagliapietra and Georg Zachmann Topic: Energy & Climate Date: November 30, 2018
Read article More on this topic More by this author

Blog Post

Machine learning and economics

Machine learning (ML), together with artificial intelligence (AI), is a hot topic. Economists have been looking into machine learning applications not only to obtain better prediction, but also for policy targeting. We review some of the contributions.

By: Silvia Merler Topic: Innovation & Competition Policy Date: November 29, 2018
Load more posts