Compelling academic papers
Jane Ambachtsheer, global head of sustainability at BNP Paribas Asset Management, on this series:
In 2017, the Global Research Alliance for Sustainable Finance and Investment (GRASFI) was formed as a collaboration of universities committed to producing high-quality interdisciplinary research and curricula on sustainable finance and investment. This series highlights 10 of the most compelling academic papers presented following their third academic conference, virtually hosted by Columbia University, with some ‘practitioner takeaways’ provided by BNP Paribas Asset Management investment professionals. We sponsor GRASFI to bring academic rigour to the pressing challenges of sustainable finance and investment. Our goal is to share these reflections with clients and the industry. We invite you to visit the GRASFI Conference website.
Central bank mandates, sustainability objectives and the promotion of green finance
One of the roles of central banks has been to maintain low and stable inflation to stop an economy running too hot or cold.
Increasingly, however, climate change and environmental risks are emerging as more relevant to banks’ analysis and actions, alongside financial stability and national employment-related responsibilities.
In ‘Central Bank Mandates, Sustainability Objectives and the Promotion of Green Finance’ , researchers analysed the mandates of 135 central banks and monetary unions from around the world to assess their sustainability credentials and the extent to which they were tasked with, implicitly or explicitly, supporting green finance.
They drew on previous work to put together the challenges central banks face when seeking to address environmental risks, and how these might be navigated.
Using the International Monetary Fund’s Legislation Database, the researchers found that 12% of central banks had ‘explicit sustainability mandates’, while 40% were mandated to support their government’s policy priorities ‘which in most cases include sustainability goals’.
Even where sustainability mandates are not explicit, some banks have adopted their own environmental policies, such as De Nederlandsche Bank in the Netherlands.
Meanwhile, under the leadership of former governor Mark Carney – himself a vocal advocate of environmental policies – the Bank of England has attempted to help address the challenges of a changing climate. While this is not explicitly included in its mandate, it does reflect the UK government’s pledge to become a net zero economy and target ‘sustainable and balanced growth’.
Bringing climate to the fore
The changing climate and its repercussions will be felt across society and will have a knock-on effect on inflation and financial stability.
Extreme weather events are becoming more common. This can hit agricultural output and increase food prices. In emerging economies, this can have a significant impact on employment and income.
Extreme weather can cause broader supply side shocks that “may cause a trade-off for central banks between stabilising inflation and stabilising output fluctuations”.
There may be a link between mitigation and falling output. The paper hypothesises that a carbon tax could cause output to decline and inflation to spike. Raising interest rates in response could exacerbate the issue by slowing the economy and strengthening the currency.
On financial stability, the paper explores the three main risks associated with climate change: transitional, physical and liability risk. The first two are seen as having a significant impact on macroeconomic stability and should be incorporated into scenario analyses.
The risks associated with a changing climate are not linear, the paper points out. Major shocks to the global financial system cannot be ruled out. However, so far few central banks and supervisory authorities have brought this into their systemic risk frameworks.
Greening the system
The paper explores how central banks can contribute to ‘greening’ the global financial system. This would require an explicit environmental mandate, which few central banks have.
The transition to a low carbon economy will require huge amounts of money to be diverted away from industries such as fossil fuels. Efforts by central banks to favour such a realignment may appear at odds with their independence and market neutrality principles
However, some banks in emerging markets have already begun to act in this way as a viable solution to tackling market failures related to climate change.
This raises issues around how far central bank mandates can be extended: having too many objectives and too few rules can be a problem. On top of this, their independence removes central banks from public accountability to an extent, meaning that unelected officials could be taking substantial actions or set climate policies.
To address this, banks “need to create the legitimacy of their actions through clearly communicating their assessment of the risks and the rationale for their policy actions”, the paper says.
Taking action on climate change is more vital than ever, and central banks can and will play a crucial role in the years ahead, through the provision of information and analysis as well as affirmative action and policy decisions.
The paper is clear, however, that national governments and policymakers must be willing to grant banks the new powers they need to lead the fight against rising global temperatures. As the research concludes: “A central bank that does not address climate risk is failing to do its job.”
Commenting on the paper, Johanna Lasker, head of the Official Institutions Group at BNP Paribas Asset Management, said:
“The authors of this paper offer a comprehensive assessment of the complex challenges and opportunities faced by central banks in determining how to incorporate climate risk into their mandates, concluding that they have a critical role to play in the development of green finance.”
 The Global Research Alliance for Sustainable Finance and Investment is a worldwide network of 19 leading universities that was established in 2017 to promote rigorous academic research into finance and responsible investment. BNP Paribas Asset Management has been the asset management sponsor of GRASFI since 2018. Through its sponsorship, BNPP AM is able to access leading academic research into sustainable finance and investment, helping to inform the broader debate.
 The paper by Simon Dikau and Ulrich Volz at SOAS Department of Economics is available here: https://www.soas.ac.uk/economics/research/workingpapers/file139494.pdf
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