Central banks have extremely powerful tools to shape the global financial system, and could steer capital flows out of fossil fuels and into cleaner energy.
But to date, most central banks have “tinkered at the edges,” and in many cases, “positively reinforced fossil fuel financing,” according to a new report. Global calls for central banks to take on a more active and constructive role in the fight against climate change are growing louder.
Very little action amid claims of “neutrality”
The primary remit of the U.S. Federal Reserve and a long line of other central banks is to ensure macroeconomic stability in the financial system. However, the banks largely claim that helping the world slash greenhouse gas emissions and prevent the worst of climate chaos is outside of their mandates.
Unchecked climate change presents catastrophic risk to the financial system.
But to “the extent that central banks’ mandates require them to preserve financial stability, they must therefore address these climate-related risks,” a report from Oil Change International states. After all, unchecked climate change presents catastrophic risk to the financial system.
However, so far, efforts from central banks are narrowly focused on increasing disclosures and transparency, and have done very little even as the risks continue to mount.
Oil Change International looked at 10 criteria to grade how central banks are addressing climate change in the years since the 2015 Paris Climate Agreement. For example, whether or not they have excluded fossil fuels from Covid-19 related asset purchases, or whether central banks use the variety of tools and regulatory authorities over commercial banks to pressure them into steering lending away from oil, gas, and coal. They also have many policy and research tools, including disclosure requirements and developing taxonomies and parameters for sustainable investments.
Not only do most of the 12 largest central banks grade poorly, but many continue to reinforce the existing fossil fuel financial arrangements. For instance, the People’s Bank of China continues to promote financial flows to coal. Germany’s Bundesbank supports “market neutrality” as a justification for refraining from supporting climate action, but “neutrality” means continuing to support fossil fuels. The U.S. Federal Reserve has paid some lip service to climate risk, but has done little.
“Since the Paris Agreement was signed, central bank executives have become increasingly outspoken about the need for their institutions to address the climate emergency,” Oil Change International wrote in its report. “But nothing that central banks have done to date has made any difference to the scale on which finance flowed to fossil fuel production. Central banks have the tools to stem fossil fuel finance, but they have not used them.”
Over a five-year period since the Paris Climate Agreement, roughly $3.8 trillion has poured into fossil fuel industries, a grim metric that demonstrates that even as governments make commitments on emissions reductions, financial flows are still not aligned with those promises.
The role of central banks
A separate report from Evergreen Action proposed five actions that the Fed must take to confront fossil fuel financing, including: mandatory climate-risk disclosure rules, climate stress tests of financial institutions, increase capital requirements for assets vulnerable to climate risk, limit non-Paris-aligned investments, and drive equitable green finance.
“Wall Street has failed to take the steps needed to protect our economy.”
“Wall Street has failed to take the steps needed to protect our economy, and to stop fueling the risks of the climate crisis,” Evergreen Action wrote. “In fact, big banks have only increased their investments in the fossil fuels that are driving climate risk.”
In July, Fed Chair Jerome Powell said that he was looking into climate stress tests for banks and financial institutions. The central bank already has the authority to conduct stress tests, dating back to the 2010 Dodd-Frank financial reform legislation.
A climate stress test would be similar, but would gauge whether an institution was prepared to handle a climate-related shock, rather than simply a financial one. A climate shock could be a natural disaster, or a blow to financial assets stemming from the energy transition.
For instance, rising sea levels put coastal real estate markets at risk, raising the prospect of financial losses for lenders or insurers. When the damage goes beyond the immediate physical devastation to a few city blocks, for example, but rises to a regional level and impacts entire sectors as financial contagion sets in, then the risk certainly rises to the level that should be on the Fed’s radar.
In January 2020, the Bank of International Settlements (BIS), a network of the world’s top central banks, warned that “green swan” events could bring down the financial system. By that, BIS referred to climate disasters that pose broad financial risks, but unlike “black swan” events, which are generally understood to be unpredictable, green swan events relate to climate disasters that at this point are all but inevitable.
The Fed has repeatedly intervened in other crises.
The argument that central banks should stay out of it and maintain “neutrality” also ignores the fact that the Fed has repeatedly intervened in other crises. The massive monetary expansion during the 2008-2009 financial crisis and again during the Covid-19 pandemic illustrates that the central bank springs into action when it sees risks to the financial system. By any measure, climate change presents just the type of crisis that would require financial rescuing from central banks.
Oil Change International called on governments to amend the charters of central banks so that they could help manage the decline of fossil fuel production by assisting in the end of financial flows into the sector. The banks should also limit fossil fuel assets directly from their portfolios and use their power to pressure commercial banks into making the same transition.
Up until now, the efforts from central banks to steer the financial system in a new direction have been painfully modest. These actions “have been underpinned by the assumption that markets, properly supervised and regulated, will produce the necessary responses to the climate crisis,” Oil Change International wrote. “The continued expansion of financial flows to fossil fuels casts significant doubt on this assumption.”
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