A game-changing report by 18 of the world’s leading central banks and financial regulators has called on central banks to lead by example and integrate climate criteria into their operations.

The Bank of England has laudably pioneered the links between issues around financial stability and climate change. It should continue to do so by becoming the first European central bank to reflect climate-related financial risks in its monetary operations, particularly its collateral framework and asset purchases.

While the Bank of England has taken steps to warn banks and insurance companies that they could be failing to price in climate-related financial risks, the BoE itself is exposed to those very same financial risks and needs to act accordingly. The BoE lends money to the banking sector against certain financial securities as guarantees, referred to as collateral. Problematically, the risk measures used by the BoE in its framework to decide which securities are safe enough to be accepted as collateral are based on private sector credit rating agencies. While private sector credit rating agencies have started to acknowledge climate related financial risks, to date these are not adequately reflected in actual ratings. Omitting climate risks in the collateral framework gives a relative advantage to carbon intensive securities that are climate risky compared to those that are climate safer.

Similarly, the BoE’s £10bn corporate bond purchase programme encompasses a carbon-intensive bias, where nearly 50 per cent of purchases were from manufacturing and electricity sectors, generating 52 per cent of emissions but providing just 11.8 per cent of gross value added (GVA).

The BoE’s collateral framework and asset purchases are extremely powerful and reverberate throughout the rest of the financial sector — affecting financial market prices and capital allocation more widely. When the BoE purchases assets or accepts them as collateral, their yields are lowered compared to other comparable ineligible assets. This means that the current structure of asset purchase programmes and collateral frameworks create better financing conditions — an implicit subsidy — for fossil fuel sectors and the corporates dependent on them.

With the recent Intergovernmental Panel on Climate Change report suggesting that we have just over a decade to limit climate catastrophe, the BoE needs to continue its commendable work as a global pioneer in this field — not just as a thought leader, but through the action it takes.

Photo credit from previous page: Financial Times

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