Central Banks and the Transition to a Low-Carbon Economy

Abstract

Climate change is a fundamental challenge for our societies. Containing it will require a profound and radical transformation of our economic system, including a substantial reorientation of investments toward low-carbon technologies. The question to what extent central banks can and should contribute to this effort is moving up agendas worldwide. Building on the research presented at a CEP DNB workshop on “Central Banking and Green Finance” in November 2017, this discussion note explores policy options available to central banks to contribute to the transition to a low-carbon economy. The studies presented in the workshop reassert that climate change is a potential risk for the stability of the financial system. Against this background, and as a first step, central banks should develop a comprehensive evaluation of climate-related systemic risks in the financial sector. They should also consider regulatory measures to mitigate these risks, in particular by implementing higher capital requirements for loans to carbon-intensive economic activities – a measure which would support the transition to a low-carbon economy, increase capital levels and thus strengthen financial system stability. Academic research also highlights that current large-scale asset purchases by central banks are biased toward incumbent carbon-intensive sectors. Central banks should further assess these biases and ensure that climate-related risks are adequately reflected in their own balance sheets as well as their collateral frameworks.