Central banks and climate change: Main issues and perspectives

Esposito, Lorenzo Article Central banks and climate change: Main issues and perspectives PSL Quarterly Review Provided in Cooperation with: Associazione Economia civile, Rome Suggested Citation: Esposito, Lorenzo (2024) : Central banks and climate change: Main issues and perspectives, PSL Quarterly Review, ISSN 2037-3643, Associazione Economia civile, Rome, Vol. 77, Iss. 311, pp. 493-509, https://doi.org/10.13133/2037-3643/18312 This Version is available at: https://hdl.handle.net/10419/324122 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0/ PSL Quarterly Review This work is licensed under a Creative Commons Attribution – Non-Commercial – No Derivatives 4.0 International License. To view a copy of this license visit http://creativecommons.org/licenses/by-nc-nd/4.0/ vol. 77 n. 311 (December 2024) Central banks and climate change: Main issues and perspectives LORENZO ESPOSITO* Abstract: In the last decades, during the unfolding of momentous events, we saw the growing awareness of the need for a transition to a sustainable economy. The radical economic and social change will require the mobilization of colossal resources, and hence the alignment of the financial system to this goal. Climate change also affects the functions of central banks. First of all, it can affect macroeconomic conditions, forcing a different approach to monetary policy and financial stability. Secondly, it affects the risks of banks and other financial intermediaries, thus financial supervision. Finally, the transition also affects the payment system. In this work, we will try to sum up the main topics concerning the links between central banks, the transition, and the possible objections to them. We conclude that an efficient transition requires that the financial markets business model become sustainable, a goal that becomes more difficult in the new geo-political situation. Bank of Italy and Università Cattolica del Sacro Cuore, Milan (Italy), email: [email protected] How to cite this article: Esposito L. (2024), “Central banks and climate change: Main issues and perspectives”, PSL Quarterly Review, 77 (311), pp. 493-509. DOI: https://doi.org/10.13133/2037-3643/18312 JEL codes: E50, P18 Keywords: central banks, financial stability, banking supervision, climate change, sustainable finance Journal homepage: http: //www.pslquarterlyreview.info Nothing is more harmful than uncertainty. (G. Carli, 2000) In the last 15 years, central banks have faced stormy times. In 2008, there occurred the strongest global financial crisis since the end of the Second World War, and it left the financial establishment and policymakers in what Greenspan described as “a state of shocked disbelief” (Andrews, 2008). Then we had the Euro crisis, and other local crises. When the situation looked stabilized, the Covid-19 pandemic broke out, provoking human, social and financial havoc. When the pandemic was receding, Russia started a war in Ukraine. The ensuing economic sanctions and the diplomatic and trade clashes between the West and the China-Russia bloc are creating the conditions for a new cold war (Harding, 2023). During the unfolding of these momentous events, we saw a growing awareness of another key threat to the world economy: climate change and the ensuing need of a transition to a green sustainable economy. 1 * The views expressed are those of the author and do not involve the responsibility of the Bank of Italy. 1 From now on, “transition” means the transition to a green sustainable economy. Article 494 Central banks and climate change: Main issues and perspectives PSL Quarterly Review This transition is the most important economic transformation that will take place globally in the coming decades. The radical change in industrial processes, energy production, transport, house building, and agriculture as well as consumer habits will require the mobilization of colossal resources, a continuous flow of technological innovations, and a new regulatory framework concerning every economic sector. If the 2008 crisis has shown the paramount importance of ensuring financial stability, extreme weather events and climate change as a whole are emerging as a new source of systemic risk for the world economy (WEF, 2017). The risks posed to financial stability by climate change are increasingly at the centre of policymaking worldwide, especially after the “tragedy of the horizon” speech by Mark Carney, Governor of the Bank of England (Carney, 2015). Some simulations have shown that global warming could increase the frequency of banking crises, also increasing their economic fallout (Lamperti et al., 2019). In fact, climate change can cause adverse macroeconomic effects (recessions, rising food or energy prices, etc.); secondly, it can lead to unforeseen risks, especially for the funders of polluting companies (as banks or bondholders), which can provoke damages to the entire financial system. The need for a rapid economic transformation also implies mobilization of the financial sector to help the transition (see ESRB, 2016; G20, 2016; and PRA, 2015). The world needs a financial system aligned with the Paris Agreement aims and, more generally, with the transition goals. For their part, it is important that banks, asset managers, and the other financial operators do not look at sustainable finance merely as a way to prop up their reputation and their product offerings but as an actual change in important aspects of their business model (Warmerdam et al., 2015). To this aim, the role of central banks and banking supervisors is also important to create effective regulatory incentives for the change. On the one hand, banks’ brown assets (those issued by companies whose activities negatively impact the climate) are still huge. For instance, the European Banking Authority (EBA) calculates the EU banks’ total exposure in these sectors at more than €2 trillion, while the sum of the high-quality component of their own funds is around €1,650 billion (EBA, 2018). On the other hand, the need for energy-related investments is also impressive, having been calculated at $830 billion annually for the period 2016-2050 (NGSF, 2019). A report by the Intergovernmental Panel on Climate Change (IPCC) of the United Nations estimated that $2,400 billion of investment will be needed annually until 2035 merely to transform energy systems (Kocher, 2019). Already the New Climate Economy Report estimated that some US$90 trillion would have been needed between 2015 and 2030 to achieve global sustainable development and climate objectives (GFT, 2018). A United Nations report put the costs to the world economy at US$6.6 trillion for 2008, which will grow to US$28.6 trillion in 2050 18% of the world GDP, (UNEP-FI, 2010). Although these numbers are staggering, delaying action is even worse: “In the absence of further action to tackle climate change, the combined negative effect on global annual GDP could be between 1.0% and 3.3% by 2060. As temperatures could continue to rise to a projected 4°C above pre-industrial levels by 2100, GDP may be hurt by between 2% and 10% by the end of the century relative to the no-damage baseline scenario” (OECD, 2015). This dramatic outcome derives from the situation on the ground in terms of warming, as many international reports have shown in the last years. In particular, the IPCC (2022) underlined that, in the 2006-2015 period, warming reached 0.87° C relative to 1850-1900, predominantly due to human activity increasing the amount of greenhouse gases in the atmosphere. Moreover, the global temperature is currently rising by 0.2°C per decade and, if this pace of warming continues, the increase would reach 1.5°C by 2040. The situation is so worrying that every resource, both public and private, must be mobilized to change direction. This is why the United Nations has issued a Green Finance Progress Report (UNEP, 2017) that includes an assessment of the L. Esposito 495 PSL Quarterly Review engagement of the financial system. As Solheim noted introducing the report: “We will not be able to truly reshape our societies without throwing the weight of the global financial system behind our ambitions and finding better and greener ways of doing business”. In the analysis of the OECD, in the absence of further action to tackle climate change, the combined negative effect on global annual GDP could reach 3.3% by 2060 (OECD, 2015). This is as if, every two years, an event of the scale of the Covid-19 pandemic would hit the planet. For their part, international financial institutions, in particular the International Monetary Fund and the Bank for International Settlements, are pushing for an increase in the efforts towards the transition (Bolton et al., 2020). This is not due solely to a moral duty felt towards the environment and the well-being of humankind but reflects the fact that climate change is already a threat to financial stability. Of course, the rapid shift of attention of central banks and policymakers is also connected to the interests of private finance (Quorning, 2023), although this time lobbying seems more aligned to general social needs. As we will see, climate change affects all the ordinary functions of a central bank, making the analysis of this connection a key point for the sound development of the financial sector. In this work, we will try to sum up the main topics that are on the table for central banks and financial operators concerning the transition, giving a wide range of references to help clarify the issues we expose. We will also describe the main objections to the role of the central banks and how this role is connected to a more prudent attitude of large financial institutions toward the transition that developed in the new geo-political situation. 1. The climate change debate and the rise of sustainable finance Environmental economics pre-existed the debate on climate change but the field is now expanding rapidly. Its main aim, as far as our topic is concerned, is “to examine how temperature, precipitation, and windstorms influence economic outcomes” (Dell et al., 2013). It is a complex analysis because data are not easy to assess, the links between weather and the economy are hard to figure out, and the effects are highly nonlinear. Ideally, economists should be able to create a loss function similar to what is done to assess the probability of default for countries and corporations. Therefore, one of the main aim of economics in this field has been the measurement of the costs of climate change. For instance, Stern found a loss of at least 5% of global GDP each year if climate change is be stopped. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% or more of GDP. In contrast, the costs of action are put at around 1% of global GDP each year (Stern, 2006). We already reported on the OECD forecast. However, these exercises come with a host of very complex assumptions. An example is the literature that deals with the connections among sectors, to analyse the overall emissions of a given commodity. The input-output analysis is widely used for this end (see Chen, 1977; UN, 2000; Miller and Blair, 2009; Guilhoto, 2021). These analyses are useful, although they suffer from the incompleteness of empirical data (Forssell and Polenske, 1998). That is the reason why so-called separate satellite accounts, like the National Accounts Matrix, including Environmental Accounts (NAMEA), have been created (Steenge, 1999; see also Eurostat, 2011 and 2016). Central banks rely on a huge mass of data to analyse the economic situation and to make their policy decisions. Climate change and the transition are connected to different kinds of data whose sources are different from those of the usual expertise of monetary authorities, for instance the aforementioned NAMEA data. Although neither inflation nor unemployment definitions are immune to quarrels, environmental issues are much more often subjected to divergent opinions, 496 Central banks and climate change: Main issues and perspectives PSL Quarterly Review even in terms of costs and benefits. For instance, Nordhaus and Moffat (2017) found very different impacts due to the limited nature of the specific studies. As Alessi et al. (2019) pointed out, there are hundreds or even thousands of impact studies concerning different areas (health, agriculture, energy, etc.) and only a few are general assessments of the whole economy. This problem also affects the impact assessment of the new rules as the EU taxonomy. Data are needed not only for public authorities but also for market operators to make more efficient decisions (Visco, 2021). These difficulties also originate from the fact that a structured discussion on climate change is a relatively recent issue. In fact, the first World Climate Conference was held in 1979, and the second not until 1990. After episodes like the 1953 ‘killer smog’ in London that showed how pollution could cause thousands of deaths in just a few days, the 1980s acid rains, and the ‘ozone hole’ over Antarctica, in 1988 the IPCC was set up by the World Meteorological Organization and UNEP to coordinate researches on global climate change. In 1992, the UN Framework Convention on Climate Change (UNFCCC) was adopted at the Rio Earth Summit. The framework called for action aimed at stabilizing atmospheric concentrations of greenhouse gases to avoid “dangerous anthropogenic (human-emitted) interference with the climate system”. In 1995 the first Conference of the Parties (COP) was held in Berlin to review implementation of the UNFCCC, followed by subsequent conferences almost every year (Sinha, 2015; UNFCCC, 1995). The proof of the new attitude by governments as well as firms and public opinion was the 1997 Kyoto Protocol (COP3), which set binding targets for 37 industrialized countries and the European Union to reduce greenhouse gas emissions by roughly 5% below 1990 levels by 2012. Not only it there were (and are) competing interests among countries, firms, and parties, but their attitudes towards the transition could also change. The US case is particularly clear, with the Kyoto Protocol signed by Clinton and refused in 2001 by Bush; a similar situation occurred with the Paris Agreement, which was signed by Obama, refused by Trump, and signed again by Biden. At any rate, after all these years, nowadays the issue is at the centre of the policy of basically every country, and the huge financial dimension we mentioned is acknowledged. A delicate issue is the distribution of the costs of the transition among countries, sectors, and economic agents. The potential for wealth and income redistribution is immense, although the costs associated with the protocol are difficult to measure and elicit strong disagreement (see Nordhaus and Boyer, 1999, and MacCracken et al., 1999). As we noted, the huge investment needed for the transition implies an important role of the financial system (Batten et al., 2016). This has resulted in the debate developing a focus on the sustainable finance that aims at finding ways to fund investments for the transition and, more generally, taking into account environmental, social, and governance considerations in the financial assets valuation (Rezende de Carvalho et al., 2016). Governments will have to intervene too. For instance, the Paris Agreement established a financial mechanism to provide financial resources to developing country parties, starting with a Green Climate Fund that has the frankly ridiculous commitment of $3.7 billion. The mobilization of private investors is not easy. Pollution is one of the most emblematic examples of negative externality (Stiglitz, 2000); therefore, the associated risks are underestimated by financial markets (Silver, 2017; Thomä and Chenet, 2017). Typically, governments tackle environmental degradation using a price mechanism such as the carbon tax. Sustainable finance is a different way to change relative prices using funding costs as a lever. What is needed is a general policy to connect all these tools. A point in favour of using finance instead of taxes is that changing the relative price of funding green projects sustainable finance could prevent the externality to be produced in the first place; after all, no economic sector can exist without extensive funding by the banking system. The interest of finance is also connected to legal L. Esposito 497 PSL Quarterly Review consequences. In fact, there is a growing literature on banks’ environment responsibility (Bouma et al., 2001) that deals with the direct legal costs and the reputational risks resulting from the funding of controversial projects and firms (Ulph and Valentini, 2004). The idea of “lender liability” is also part of many laws, such as the US 1980 Comprehensive Environmental Response, Compensation, and Liability Act (Bearden, 2012; see also Wolford, 2014), the 1993 Lugano Convention (EC, 1993), and the UK 1995 Environment Act (Dechezleprêtre and Sato, 2014). These laws confirm, although in a negative way, the importance of the connections between the banking system and the transition. Moreover, the use of fiscal policy for the transition opens up many debates (Dafermos and Nikolaidi, 2019; Faiella and Lavecchia, 2021). Among the major issues we must prevent are unfair competition due to green fiscal policies in only some countries (McEvoy and McGinty, 2018; Weitzman, 2014) and the difficulty of conceiving a unified set-up for fiscal policy that avoids the problems arising from partial equilibrium analyses (Bovenberg and Goulder, 2001). Fiscal policies are paramount also, because, although sustainable (private) finance is important, no transition is possible without a strong direct commitment by the states, which are the only investors with a long-term perspective (Mazzucato, 2013). 2. Climate change and financial risks Scientific literature has identified two main risks by which climate change affects the financial system: physical risk and transition risk. Physical risk is connected to catastrophic weather events and their higher frequencies. It can have an acute expression, like tornados and floods, and a chronic expression, as with a permanent reduction in snowfall or higher average temperatures. Both have consequences on firms’ revenues and costs and hence on the associated credit risk for their lenders. Transition risk is connected to changes in public sector policies, innovation, and the affordability of existing technologies due to the shift towards a low carbon economy. This kind of risk is connected to the governments’ stance towards the transition, which, in turn, is connected to public opinion on the issue (ECB, 2020; for the Italian scenario, see Matikainen et al., 2017). Other categories of risks often analysed in this context are the reputational risk (Ulph and Valentini, 2004) and the legal risk, which are in different ways linked to the transition. Broadly speaking, financial risks are complex to measure, and their connection with environmental make them even more complex. However, firms and financial operators are trying to take into account the effects of climate change in their business models. For instance, credit rating agencies are incorporating climate risks in their assessment (CIEL, 2015); this is also to prevent possible litigation. Unfortunately, many surveys show that the timeframe of a credit rating is still too brief and, as a result, many long-term sustainability risks are not fully taken into account. One important asset manager concluded: “Our research suggests many of these risks are not priced in. Why? First, financial markets tend to be short-sighted – and underestimate risks that appear uncertain and distant. This may lead to a discounting of physical risks that are already biting. Second is a lack of tools and data” (BlackRock, 2019). Models are difficult to produce because climate risks’ specific characteristics (for instance, deep uncertainty and nonlinearity) pose fundamental challenges to traditional methods for macroeconomic and financial analysis, which have been shown to be unable to capture these characteristics (Battiston et al., 2020; see also Zlatic et al., 2015). Several studies have tried to assess empirically the impact of transition risks and physical risks on macro stability and/or financial stability, for instance using ecological (E-)DSGE models (Vollmer, 2022). More generally, many different models have been proposed to predict the environmental impacts of energy policy scenarios, from the already mentioned input- 498 Central banks and climate change: Main issues and perspectives PSL Quarterly Review output analysis (Serrano, 2007; Igos et al., 2015) to agent-based models (Lamperti et al., 2019), to the stock-flow consistent approach (Jackson, 2020). The problem is that all these models entail complex measurement of the effects of future policies, such as the carbon tax, that affect costs and revenues of the firms (Carattini et al., 2021). However, transition risk is endogenous and hence intrinsically difficult to introduce in an economic model. For instance, the deadline for the use of fossil fuels is decisive to assess the value of the assets of oil companies. Different assumptions produce very different scenarios in terms of investment and stranded assets and, thus, on a macroeconomic level, on economic growth, income distribution, etc. (for a recent survey on the connection between stranded assets and climate change, see Daumas, 2023). The difficulties derive also from the fact that causality can go both ways: emissions influence macroeconomic development, for instance growth, but growth influences emissions. This makes it difficult to shape rules and policies to tame climate change. But, for all the uncertainties, what is already clear is that climate change significantly affects key industries. For instance, agricultural production is strongly hit, with ensuing consequences on food prices and inflation. The transport industry is also heavily impacted, and this, once again, has a significant effect on prices. Given that decarbonizing is costly, the complexity of climate risks and the long-term horizons in which they can materialize can be used as an excuse to underestimate climate risks (ECB, 2021a). Moreover, since environment-related costs are an externality, they cannot be fully priced in the default risks of the firms. For instance, it has been noted that the prices of financial assets of fossil-fuel-producing firms do not fully reflect their credit risks (Pereira da Silva, 2019). Sometimes market indicators find that green finance is working and “companies with high environmental performance benefit from a lower cost of debt” (Fatica et al., 2021); other studies found that green assets underperform their asset class (Alessi et al., 2021), even if there are signs that markets are reflecting the increasing risk of brown firms because of a strong increase in climate change risk awareness (Donadelli et al., 2019). Other reports estimated that “the median additional annual returns of coal and oil firms are expected to drop to around –4% in a 35-year horizon” (Moliterni and Vernizzi, 2017). Another problem of using the ordinary measurement of financial contagion is that financial risk metrics, like the value at risk measurement, are backward looking, while funders should be able to identify prospective default risks (Roncoroni et al., 2021). It is also difficult to assess whether this performance is connected to the actual default risk of the greener firms or to investor preferences (Ilhan et al., 2019). At any rate, studies on climate risk as a potential source of financial disruption are multiplying (Aglietta and Espagne, 2016; Scott et al., 2017), as it is clear that policymakers and financial operators must deal with these risks. 3. The role of the central banks and what they are actually doing Economic policies are aimed at intervening in problems that the price system and markets in general cannot face (Chenet et al., 2021). Climate change is probably the clearest example of this failure. As we noted, every policy should be grounded in empirical data but, in the case of climate change, uncertainty is very strong and this makes it difficult for the government to shape a tax or a subsidy. For instance, the range of estimates for the carbon tax needed to reduce emissions in European OECD countries ranges from $25 to $825 per ton of carbon (McKibbin and Wilcoxen, 2002). These uncertainties also derive from the vagueness that characterizes international agreements like the Kyoto protocol, which are political more than technical documents. Given this uncertain framework, it is difficult to structure an efficient policy, because measures like a carbon tax can affect prices and the economy as a whole in many different ways (Ferrari and Nispi Landi, L. Esposito 499 PSL Quarterly Review 2023). From one side, the quicker the transition the better, because adverse effects are reduced. From the other, a too-rapid transition, in terms of taxes, banning fossil fuels, etc., could be unsustainable, for instance because it lowers by too much firms’ profitability or raises prices too high. The build-up of productive capacity takes time and the wrong policy can drive prices of a given commodity up, forcing a strong subsidy to make it affordable. Both high prices and high subsidies can have important macroeconomic effects. The issue of inflation has been unimportant for decades but, with the pandemic and the war in Ukraine, it has returned. This development has been connected to disruptions in global supply chains, together with geopolitical issues weighting on fossil fuel prices. This experience has opened a debate on “greenflation” (Olovsson and Vestin, 2023). This discussion shows that central banks are touched by climate change issues in a number of ways. Basically, every major institutional function that central banks perform is affected. Firstly, as policymakers, monetary authorities are interested in assessing whether climate change will have an impact on growth and inflation (as with “greenflation”), an issue that affects both economic research and market operations duties of central banks. In the last couple of years, inflation has been driven by energy prices and supply chain problems, but a similar dynamic can result from extreme climate events, and central banks have already been analysing how they should respond to catastrophic events (Cantelmo et al., 2024). The first analyses showed a limited impact of climatic disaster on inflation in advanced economies (Mersch, 2018) but this could change because of political decisions. For instance, by changing the prices of energy products and their share in the goods’ price basket, climate policies could impact the inflation rate (Bernardini et al., 2021). Given the growing economic impact of climate change, monetary policy decisions will be increasingly connected to it. In the Eurozone, the European Central Bank (ECB) monetary strategy decided by the Governing Council for 2021 (ECB, 2021b) includes a climate action plan, and the ECB published a number of documents on the issue (for instance, ECB, 2021a) to discuss the consideration of climate change in the monetary policy of the Eurozone. The People’s Bank of China went even further, introducing a range of measures aimed at greening its policy, while the central banks of Brazil, India, and Japan have introduced credit facilities that favour sectors more connected to the transition (Vollmer, 2022). Secondly, as banking supervisors, central banks are interested in deepening the links between climate change and banks’ risks and business models. For instance, according to the Institute of International Finance, more than US$2.5 trillion in global financial assets in 2016 were subject to some kind of risk derived from the impacts of climate change (Canuto, 2020). This amount has increased ever since. Given the possible rapid shifts in asset prices, prudential policies should evolve to acknowledge the effects of climate risk, although it is not easy (Grippa et al., 2019). As for macroprudential policies, although they are not necessary in the explicit mandate of central banks, financial stability has become more and more important, even before the great financial crisis of 2008, due to the frequent financial crises that punctuated international markets from the 1990s. After 2008, for at least a decade, maintaining financial stability has been the key duty of central banks. Once again, experts in academia, in the financial system, and at the authorities are trying to understand the connection between the transition and the stability of the financial system. This is not an easy task for the measurement issues we cited. Also, the payment system is interested in the transition, for direct and indirect motivations. The most direct one is that digital payments have much less of a carbon footprint. However, this is not true for crypto-currencies due to their proof-of-work mechanism. For instance, the Cambridge Bitcoin Electricity Consumption Index measured the electricity consumed to mine Bitcoin in 2022 at a minimum of 176 TWh (terawatt-hours), which is around half of the entire 500 Central banks and climate change: Main issues and perspectives PSL Quarterly Review consumption of a country like Italy; for 2023, the consumption was in excess of 241 TWh. 2 This is why there is a discussion in the cryptocurrency community about switching to the proof of stake mechanism. 3 The use of other forms of digital payment, for instance central banks’ digital currencies, would be far better for the environment. They could also help financial inclusion, thus improving other dimensions of the environmental, social and governance (ESG) goals (Banet et al., 2022; Auer et al., 2022). This issue is connected to the broader discussion on green fintech (UNEP, 2017). Finally, it has been noted that carbon-intensive sectors accounted for nearly half of the bonds eligible for the ECB’s corporate sector purchase programme at its beginning (Mersch, 2018), showing that the credit risk posed by brown assets is an important consideration for central banks as well as investors. If it is now widely accepted that central banks should include the effects of climate change in programming their action, the way to achieve it can vary significantly. A reduced approach sees the role of central banks only inasmuch as they help to reduce a negative externality, both in their own investment and as regulators (Thiemann et al., 2022). In this sense, central banks serve as an example, for instance in measuring climate-related financial risks (Bernardini et al. 2021). However, after the global financial crisis and the pandemic, the role of central banks is far more important than before. This larger role has translated into the field of transition. It can be seen in the founding of the Network of Greening the Financial System (NGFS) in December 2017, a selfdubbed ‘Coalition of the Willing’ (NGFS, 2018). The network was initially founded by eight central banks and regulators, including the Bank of England, Banque de France, and Bundesbank, but over the years it has grown in importance and duties, pointing to a strong change in the central banks’ commitment regarding climate change. Given this development, the central banks’ tools are evolving. For monetary policy, the first step was to develop methodologies and tools that promote a better understanding of these risks (Campiglio et al., 2018) and that take them into account as far as policy is concerned. For instance, on July 2021, the ECB signaled an important shift in its monetary policy strategy when it released an action plan to integrate climate change into the core of its missions (Ribeiro and Schröder Bosch, 2021). The stage of collecting data is paramount because, for now, these data are “not sufficiently consistent, comparable, granular and reliable” (FSB, 2022). However, at least in Europe, the standardized and complete classification system proposed by the EU taxonomy has greatly helped (EBA, 2022). On the basis of a well-structured taxonomy of industries and financial products, a “green quantitative easing” could be attempted, with the aim of increasing the green bonds held by central banks to reduce the interest rate paid by green firms (Ferrari and Nispi Landi, 2024). As far as banking supervision is concerned, a first example is the green asset ratio proposed by the EBA as a key performance indicator for the EU banks (EBA, 2021). In the specific field of prudential regulation, there is a debate on how to incorporate risks from climate change into the traditional supervision tools such as capital requirement and risk weighted assets (Esposito et al., 2019; EBA, 2022; Hidalgo-Oñate et al., 2023, for a recent survey). Other examples of microprudential tools are the SME (small and medium-sized enterprises) supporting factor and the green weighting factor (Berenguer et al., 2020). Even in the framework of Basel III, a possible funding gap for the green economy has grown (Liebreich, 2013; Narbel, 2013). This analysis is important, because it is easier to pledge brown-sector-related assets as collateral, thus discouraging the greening of financial assets (Andersen, 2017). Secondly, in a situation of credit 2 See https://ccaf.io/cbnsi/cbeci 3 See https://ethereum.org/en/developers/docs/consensus-mechanisms/pos/ L. Esposito 507 PSL Quarterly Review Fatica S., Panzica R. and Rancan M. (2021), “The pricing of Green Bonds: Are Financial Institutions Special?”, Journal of Financial Stability, 54 (June), art. 100873. Ferrari A. and Nispi Landi V. (2023), “Will the Green Transition Be Inflationary? Expectations Matter”, ECB Working Paper, no. 2726, Frankfurt a.M.: European Central Bank. Ferrari A. and Nispi Landi V. (2024). “Whatever it Takes to Save the Planet? Central banks and Unconventional Green Policy”, Temi di Discussione (working paper), Rome: Bank of Italy, No. 1320. Ferrer R. and Gili R. M. (2021), “Central Banks and Climate Change: to Act or not to Act”, CaixaBank Research, June 14. Available online. Forssell O. and Polenske K.R. (1998), “Introduction: Input–Output and the Environment”, Economic Systems Research, 10 (2), pp. 91–97. FSB. (2022). “Supervisory and Regulatory Approaches to Climate-related Risks”, Interim Report, Basel: Financial Stability Board. G20 (2016), G20 Green Finance Synthesis Report, September 5, G20 Green Finance Study Group. Available online. GAC – Global Agenda Council on New Energy Architecture (2013), Financial Regulation – Biased against Clean Energy and Green Infrastructure?, Geneva: World Economic Forum. Available online. Gelles D. (2024), “More Wall Street Firms Are Flip-Flopping on Climate. Here’s Why”, Wall Street Journal, February 19. Available online. GFT – Green Financial Taskforce (2018), “Accelerating Green Finance”, London: Green Financial Taskforce. Available online. Ghisetti C., Mazzanti M., Mancinelli S. and Zoli M. (2015), “Do Financial Constraints Make the Environment Worse Off? Understanding the Effects of Financial Barriers on Environmental Innovations”, SEEDS Working Paper, no. 1/2015, Ferrara: University of Ferrara, Sustainability Environmental Economics and Dynamics Studies. Available online. Grippa P., Schmittmann J. and Suntheim F. (2019), “Climate Change and Financial Risk”, Finance & Development, December, pp. 26-29. Available online. Guilhoto Joaquim J. M. (2021), “Input–Output Models Applied to Environmental Analysis”, In Shugart Hank (ed.), Oxford Research Encyclopedia of Environmental Science, London: Oxford University Press. Hansen L.P. (2021), “Central Banking Challenges Posed by Uncertain Climate Change and Natural Disasters”, BFI Working Paper, No. 2021-64, Chicago: University of Chicago, Becker Friedman Institute. Harding A. (2023), “America Is in a New Cold War With China”, The Heritage Foundation, March 29. Available online. Hidalgo-Oñate D., Fuertes-Fuertes I. and Cabedo J. D. (2023). “Climate-related Prudential Regulation Tools in the Context of Sustainable and Responsible Investment: A Systematic Review”, Climate Policy, 23(6), pp. 704-721. HLEG – High Level Expert Group on Sustainable Finance (2017), Interim Report, Brussels: European Union. Available online. HLEG – High Level Expert Group on Sustainable Finance (2018), Final Report, Brussels: European Union. Available online. Igos E., Rugani B., Rege S., Benmetto E., Drouet L. and Zachary D.S. (2015), “Combination of Equilibrium Models and Hybrid Life Cycle–Input-Output Analysis to Predict the Environmental Impacts of Energy Policy Scenarios”, Applied Energy, 145, pp. 234-245. Ilhan E., Krueger P., Sautner Z. and Starks L.T. (2019), “Institutional Investors’ Views and Preferences on Climate Risk Disclosure”, Swiss Finance Institute Research Paper Series, no. 19-66, Geneva: Swiss Finance Institute. IPCC – Intergovernmental Panel on Climate Change (2022), Global Warming of 1.5°C. Summary for Policymakers, Technical Summary and Frequently Asked Questions, Geneva: Intergovernmental Panel on Climate Change. Available online. Jackson A. (2020), “A Stock-flow Consistent Framework for the Analysis of Stranded Assets and the Transition to a Low Carbon Economy”, PhD doctoral thesis, Guildford: University of Surrey. Available online. Jia J. and Ilzetzki E. (2021), “The ECB’s Green Agenda”, CEPR.org, March 10. Available online. Khasreen M., Banfill P.F.G. and Menzies G.F. (2019), “Life-Cycle Assessment and the Environmental Impact of Buildings: A Review”, Sustainability; 3, pp. 674-701. Kocher I. (2019), “Green finance, at the heart of the ecological transition”, in Greening the Financial System: The New Frontier (pp. 59-68), special issue of Financial Stability Review, no. 23, June. Paris: Banque de France. Available online. Lakhani N. and Rushe D. (2024), “US Banks abandon ‘bare minimum’ Environmental Standards Projects, Alarming Climate Groups”, The Guardian, March 6. Available online. Lamperti F., Bosetti V., Roventini A. and Tavoni M. (2019), “The Public Costs of Climate-induced Financial Instability”, Nature Climate Change, 9, pp. 829-833. Landau J. and Brunnermeier M. (2020), “Central banks and Climate Change”, CEPR.org, January 15. Available online. Langley P. and Morris J. H. (2020), “Central Banks: Climate Governors of Last Resort?”, Economy and Space, 52(8), pp. 1471–1479. 508 Central banks and climate change: Main issues and perspectives PSL Quarterly Review MacCracken C.N., Edmonds J.A., Kim S.H. and Sands R.D. (1999), “The Economics of the Kyoto Protocol”, The Energy Journal, 20(1_suppl.), pp. 25-71. Masciandaro D. and Russo R. (2022), “Central Banks and Climate Policy: Unpleasant Trade–Offs? A Principal–Agent Approach”, Bocconi Working Paper Series, no. 181, June, Milan: Bocconi University, Baffi Carefin. Available online. Matikainen S., Campiglio E. and Zenghelis D. (2017), “The Climate Impact of Quantitative Easing”, CCCEP Policy Paper, May, London: LSE Grantham Research Institute on Climate Change and the Environment and Centre for Climate Change Economics and Policy. Available online. Mazzucato M. (2013), The Entrepreneurial State: Debunking Public vs. Private Sector Myths, London: Anthem Press. McEvoy D.M. and McGinty M. (2018), “Negotiating a Uniform Emissions Tax in International Environmental Agreements”, Journal of Environmental Economics and Management, 90(C), pp. 217-231. McKibbin J. and Wilcoxen P.J. (2002), “The Role of Economics in Climate Change Policy”, Journal of Economic Perspectives, 16(2), pp. 107-129. Mersch Y. (2018), “Climate Change and Central Banking”, speech by Yves Mersch, Member of the Executive Board of the ECB, Workshop discussion: Sustainability is becoming mainstream, Frankfurt, 27 November. Available online. Miller R.E. and Blair PD. (2009), Input–Output Analysis. Foundations and Extensions, Cambridge (MA): Cambridge University Press. Moliterni F., Vernizzi F. and Pareglio S. (2017). “Disclosing Climate-Related Risks: Current and Future Prospects”, FEEM Policy Brief, no. 3/2017, July, Milan: Fondazione Eni Enrico Mattei. Available online. Narbel P.A. (2013), “The Likely Impact of Basel III on a Bank’s Appetite for Renewable Energy Financing”, Norwegian School of Economics Discussion Paper, no. 2013/10, Bergen: NHH Norwegian School of Economics. NGFS – Central Banks and Supervisors Network for Greening the Financial System (2018), NGFS First Progress Report, October, Paris: Network for the Greening of the Financial System. Available online. NGFS – Central Banks and Supervisors Network for Greening the Financial System (2019), A Call for Action. Climate Change as a Source of Financial Risk, April, Paris: Network for Greening the Financial System. Available online. Nordhaus W.D. and Boyer J.D. (1999), “Requiem for Kyoto”, The Energy Journal, 20, pp. 93-120. Nordhaus W.D. and Moffat A. (2017), “A Survey of Global Impacts of Climate Change: Replication, Survey Methods, and a Statistical Analysis”, NBER Working Paper, no. 23646, Cambridge (MA): National Bureau of Economic Research. OECD – Organisation for Economic Co-operation and Development (2015), The Economic Consequences of Climate Change, Paris: OECD Publishing. Available online. Olovsson C. and Vestin D. (2023), “Will a Green Transition lead to Greenflation?”, SUERF Policy Brief, no. 577, Wien: The European Money and Finance Forum – Société Universitaire Européenne de Recherches Financières. Available online. Pereira da Silva L.A. (2019), “Research on Climate-related Risks and Financial Stability: An ‘Epistemological Break’?”, remarks by Mr Luiz Awazu Pereira da Silva, Deputy General Manager of the BIS, at the Conference of the Central Banks and Supervisors Network for Greening the Financial System (NGFS), Paris, 17 April. Available online. PRA – Prudential Regulation Authority (2015), The Impact of Climate Change on the UK Insurance sector, London: Bank of England, Prudential Regulation Authority. Available online. Quorning S. (2023), “The ‘Climate Shift’ in Central Banks: how Field Arbitrageurs Paved the Way for Climate Stress Testing”, Review of International Political Economy, 31(1), pp. 74-96. Reuters (2022), “Global Green Finance Rises over 100 Fold in the Past Decade -Study”, Reuters.Com, March 31. Available online. Rezende de Carvalho F.M.C., Amorim Sobreiro V., Kimura H. and de Moraes Barboza F.L. (2016), “A Systematic Review of Literature about Finance and Sustainability”, Journal of Sustainable Finance & Investment, 6(2), pp. 112-147. Ribeiro H.B. and Schröder Bosch J. (2021), “Climate as a Monetary Policy Dilemma: A Critical Investigation into the European Central Bank’s “Green” Framework” thesis for the EPOG Erasmus Mundus Joint Master’s Degree, Paris. Available online. Roncoroni A., Battiston S., Escobar-Farfán L.O.L. and Martnez-Jaramillo S. (2021), “Climate Risk and Financial Stability in the Network of Banks and Investment Funds”, Journal of Financial Stability, 54 (June), art. 100870. Scott M., van Huizen J. and Carsten J. (2017), “The Bank of England’s Response to Climate Change”, Bank of England Quarterly Bulletin, Q2, pp. 98-109. Available online. Serrano M. (2007), “The Production and Consumption Accounting Principles as a Guideline for Designing Environmental Tax Policy”, FEEM Nota di Lavoro 8-2007, Milan: Fondazione Eni Enrico Mattei. Silver N. (2017), “Blindness to Risk: why Institutional Investors Ignore the Risk of Stranded Assets”, Journal of Sustainable Finance & Investment, 7(1), pp. 99-113. Sinha S. (2015), “COP21: All about History, Goals and Timeline of Paris Climate Change Conference”, International Business Times, November 30. Available online. Steenge A.E. (1999), “Input–Output Theory and Institutional Aspects of Environmental Policy”, Structural Change and Economic Dynamics 10(1), pp. 161-176. L. Esposito 509 PSL Quarterly Review Stern N. (ed.) (2006), The Economics of Climate Change: The Stern Review, London: HM Treasury. Stiglitz J.E. (2000), Economics of the Public Sector, New York: W.W. Norton. TEG – Technical Expert Group on Sustainable Finance (2019), Taxonomy Technical Report, Brussels: European Union. Available online. The Economist (2019), “Green Envy: The Rights and Wrongs of Central-Bank Greenery”, December 14. Available online. Thiemann M., Buttner T. and Kessler O. (2022), “Beyond Market Neutrality? Central Banks and the Problem of Climate Change”, Finance and Society, 9(1), pp. 1-21. Thomä J. and Chenet H. (2017), “Transition Risks and Market Failure: a Theoretical Discourse on why Financial Models and Economic Agents May Misprice Risk Related to the Transition to a Low-carbon Economy”, Journal of Sustainable Finance & Investment, 7(1), pp. 82-98. Tirole J. (2022), “Socially Responsible Agencies”, mimeo Toulouse School of Economics (TSE). Available online. Ulph A. and Valentini L. (2004), “Environmental Liability and the Capital Structure of Firms”, Resource and Energy Economics; 26(4), pp. 393-410. UN – United Nations (2000), Integrated Environmental and Economic Accounting: An Operational Manual. Studies on Methods, New York: United Nations. Available online. UNEP – United Nation Environment Programme (2017), Green Finance Progress Report, July, New York: United Nations. Available online. UNEP – United Nation Environment Programme (2010), Universal Ownership: Why Externalities Matter to Institutional Investors, New York: United Nations, PRI Association and UNEP-FI. UNFCCC – United Nations Framework Convention on Climate Change (1995), Report of the Conference of the Parties on its First Session. Addendum Part Two: Action taken by the Conference of the Parties at its First Session, Berlin 28 March–7 April, New York: United Nations Framework Convention on Climate Change. Available online. UNFCCC – United Nations Framework Convention on Climate Change (2015), Adoption of the Paris Agreement, New York: United Nations Framework Convention on Climate Change. Available online. Visco V. (2021), “The Conference Messages in Light of the G20 Presidency Programme”, remarks by Ignazio Visco, Governor of the Bank of Italy, at The Green Swan 2021 Global Virtual Conference, Bank for International Settlements, 4 June 2021, Rome: Bank of Italy. Available online. Vollmer U. (2022), “Central Bank Policies and Climate Change. Where Do We Stand?”, Credit and Capital Markets, 55(3), pp. 381-411. Walsh T. (2021), “UN PRI Raises the ESG Bar for Signatories”, IFRE.Com, April 15. Available online. Warmerdam W., Christopoulou A., Herder A., Bosma C., de Wilde J., Riemersma M. and van Gelder J.W. (2015), Undermining Our Future. A Study of Banks’ Investments in Selected Companies Attributable to Fossil Fuels and Renewable Energy, The Hague: Profundo Banktrack and Fair Finance Guide International. Wass S., Wu J., Yamaguchi Y. and Ramos M. (2023). “Global Green Bond Issuance Poised for Rebound in 2023 Amid Policy Push”, S&P Global Market Intelligence, January 25. Available online. WEF – World Economic Forum (2017), The Global Risks Report 2017. 12th Edition, Geneva: World Economic Forum. Available online. Weitzman M.L. (2014), “Can Negotiating a Uniform Carbon Price Help to Internalize the Global Warming Externality?”, Journal of the Association of Environmental and Resource Economists, 1 (1/2), pp. 29-49. Wolford E.A. (2014), “Lender Liability under CERCLA: Interpreting the Security Interest Exemption Using Common-Law Principles of Lender Liability”, Notre Dame Law Review, 67(4), pp. 1161-1213. Zlatic V., Gabbi G. and Abraham H. (2015), “Reduction of Systemic Risk by Means of Pigouvian Taxation”, PLoS ONE, 10(7), art. e0114928.