Forbes


Last year, central bank chiefs in the US and Europe for the first time widely embraced the necessity of taking action on climate change.

Why Central Banks are talking up the importance of climate change action — and pouring money into fossil fuels- oil and gas 360

Source: Forbes

Christine Lagarde, the new head of the European Central Bank (ECB), vowed during her confirmation hearings in September to make climate change a “mission critical” priority. Mark Carney, the former Bank of England chief, in December called for a “new financial system” to safeguard against climate-related financial threats. And US Federal Reserve chairman Jerome Powell has said that central banks must ensure that economies are “resilient and robust” to the risks of climate change.

Yet during the economic crisis caused by Covid-19, central banks around the world have showered coal, oil and gas companies with tens of billions of dollars, just as they have every other sector in the global economy. It seemed as though their climate ambitions had vanished in a sea of financing that knows no distinction between solar farms and smog-belching coal plants.

Critics have asked: given the financial risks posed by climate change, why not exclude fossil fuel companies from new rounds of financing? In a letter in November, 164 civil society groups and experts, including world-class economists Adair Turner and Adam Tooze, addressed a letter to Christine Lagarde imploring her to do just that by purging the ECB’s carbon-related assets.

Yet neither the ECB nor the Fed — nor any other large central bank — is likely to soon start discriminating against the fossil fuel sector, economists say. Central banks are notoriously wary of overstepping their limited mandates. Rather than risk it, they are inclined to wait until governments vest them with greater authority before they start rejecting the bond prospectuses of companies building coal plants or oil pipelines.

“[Central banks] are inherently conservative organisations and it is not their job to pick and choose different sectors,” said Oxford University professor Cameron Hepburn in emailed comments.

Central bank money is blind

The Federal Reserve’s balance sheet — or the total value of all the liabilities and assets it owns — has swelled by $3 trillion in just a few months as it buys up the loans and bonds of companies large and small in an effort to stave off a prolonged recession.

If the Fed continues buying up the debt of fossil fuel companies at the same rate, it could end up paying for as many as $19 billion of corporate bonds issued by the fossil fuel sector, according to a new report by UK-based Influence Map, a non-profit that tracks how corporations influence climate policy.

That is striking, Influence Map says, because debt issued by the energy sector has badly under-performed every other sector of the US economy that the group examined, from communications to finance. Since 2015, the credit rating scores of bonds issued by companies in the energy sector — categorized to only include oil, gas, coal and related companies — have declined 13%. The next greatest decline is from the consumer staples industry, whose average credit ratings declined only 6% over the same time period.

In other words: the financial risks that climate change poses to the economy are not vague, distant possibilities. They are already showing up in the valuations of a big part of the economy. “This could be a huge risk,” said Dylan Tanner, executive director of Influence Map. “The Fed could end up with stuff that’s deteriorating in value.”

Even in Europe, where governments have unveiled massive fiscal policy packages to green the economy, the ECB appears to be treating the bonds of oil and gas firms largely the same as bonds from other parts of the economy. Details of which assets the ECB has purchased through its bond-buying programs aren’t readily available. But reports by campaigner groups Reclaim Finance and Greenpeace say that the ECB has purchased billions of euros’ worth of bonds from fossil fuel companies such as Fortum, Eni and Shell.

To critics, this all seems like a slap in the face. Fossil fuel companies should be suffering the consequences of their poor financial track records, they argue — not receiving bailouts.

Not their place 

Climate change is a substantial threat to the world economy, economists agree. Nevertheless, absent guidelines handed down by legislatures, it is simply not the place of central banks to determine which industries get financing and which don’t, they say. Even if central banks base their decisions solely on the financial performance of a given sector, there is still a risk that discriminating against or in favor of it could be construed as political.

It could also set a dangerous precedent for central bank activism, some warn. “Today’s [central bank] might choose to be harsh with oil and gas companies on the basis that one day they’ll be shunned by investors and regulators. Tomorrow’s policymakers might use that precedent to take a tougher stance against a high-debt country, if they feared it was headed for trouble,” wrote Ferdinando Giugliano in a Bloomberg Opinion piece in February.

Traditionally, central banks have had narrow mandates. In the US, a 1977 law amended by Congress empowered the Federal Reserve with the “dual mandate” of ensuring stable prices and minimizing long-term unemployment. The ECB, formed in 1998 shortly before the creation of the euro, aims to ensure price stability.

Both the Fed and the ECB are loathe to stray beyond those mandates. And indeed, they risk violating the law if they do. In May, a German constitutional court ruled that the ECB needed to justify the vast scale of its bond-buying program to ensure it did not overstep its policy objectives. The court threatened to block fresh purchases of German bonds.

There is a chance — perhaps a good chance — that governments in the future will choose to expand the mandates of central banks to include protecting against the financial risks of climate change. In that case, it may not be surprising if central banks suddenly decided to stop buying up the bonds of fossil fuel companies and start buying extra amounts of bonds from renewable energy companies.

“It is fundamentally the role of the finance ministries to put in place policies that correct prices, and build the new clean industries and cities for tomorrow,” said Hepburn, the Oxford professor, suggesting that central banks will wait for their cue.

During her confirmation hearings, Christine Lagarde hinted that the ECB would be ready to lean into a role as a climate-conscious central bank if the bank were ever vested with that authority. She told members of Parliament during her confirmation hearings that the bank could “direct” its asset purchases toward green bonds once regulators agree on a common framework for sustainable finance, the Financial Times reported in December.

Jerome Powell, on the other hand, has not given such signals. “Climate change is a very important issue, but it’s essentially assigned to many other agencies in the federal government and state governments for leadership on that,” he has said.

As the financial risks of climate change continue to show up in today’s economy, and as governments continue to evolve towards firmer stances, central banks may one day find that legislatures have endowed them with a mandate to start discriminating between solar farms and coal plants. For now, though, they mostly steer clear of such distinctions.


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