The world’s largest central banks are joining the fight against climate change, figuring that doing nothing is riskier than getting involved. Melting glaciers can seem like a big leap from monetary policy, but more and more banks are saying that they have to respond to things that have the potential to disrupt economies globally. Some have received new mandates from their governments while others are exploring ways to contribute under existing rules. Still, critics say they can and should go a lot further.

1. What got central banks interested?

A growing body of research suggests that climate change poses the greatest long-run threat to the global economy, including inflation and financial stability, the traditional purview of central banks. Even if the ambitious goal set in the 2015 Paris Agreement of limiting global temperature gains to 2 degrees Celsius above pre-industrial levels is met, the world’s economies are likely to be affected in multiple ways, from lower productivity on farms and construction sites to increased mortality and migration. That’s in addition to damage from more extreme weather events and coastal flooding that could run into the trillions of dollars by 2100. Then there are risks to the financial system.

2. What are those risks?

In 2015, former Bank of England governor Mark Carney raised an alarm about the “tragedy” of climate change and warned specifically about “re-pricing” events. That includes physical damage that destroys the value of assets (such as waterfront properties), imposes new liabilities on companies (as shown by California utility giant PG&E Corp.’s wildfire-driven bankruptcy) or sharply raises insurance prices. Another risk is a sudden slump in the value of certain assets because of drastic government action to combat climate change, like the introduction of a steep carbon tax or regulations that keep fossil fuels in the ground. “The speed at which such re-pricing occurs is uncertain and could be decisive for financial stability,” Carney said.

3. Did anything come out of that warning?

Two years later, Carney and several peers created the Network for Greening the Financial System (NGFS), a group that’s grown to nearly 100 central banks and related organizations that swap research and potential policy solutions. In 2019, the group created a set of guidelines that urges peers to price in climate change risk when regulating financial companies and to invest with sustainability goals in mind for their own portfolios. In 2021 it outlined green options for monetary policy itself.

4. What are some of the tools?

Central banks can have an impact through research, regulation and the way they run their own institutions. Research is the most indirect route, though it informs policy makers; it’s usually a central bank’s first step. They can also use their regulatory powers to force banks to calculate and disclose their climate-related risks, and can include climate-repricing scenarios in the stress tests they require to make sure banks are prepared for losses. That could have the effect of dampening a bank’s appetite for fossil-fuel investments or lending, and spur alternative energies.

5. What about monetary policy?

That’s more controversial, particularly in places where the government isn’t likely to change the central-bank mandate anytime soon. Still, options are starting to emerge. Those include more sustainable instruments so policy makers don’t fuel financial-stability risks, green bank lending, changes to collateral rules and shifting asset-purchase programs to limit exposure to so-called brown industries with high greenhouse gas emissions. That’s not the same as green quantitative easing, where central banks would deliberately funnel bond-buying toward green projects and companies and thus lower borrowing costs for such industries. Many policy makers argue that would go too far.

6. So what are central banks doing?

Each has its own approach, depending on its legal mandate and its government’s priorities:

• The Bank of Japan is looking to spur private-sector efforts to respond to global warming by providing funds for bank lending to climate-friendly businesses.

• The People’s Bank of China, a more centralized authority, provides direct investment in sustainable projects, encourages issuance of green bonds, and is studying policy tools to provide cheaper funding to institutions supporting emission-cutting projects.

• The Bank of Canada announced a pilot project with the country’s banking regulator in 2020 to help businesses explore how they may be exposed to climate-related risks.

• Policy makers at the Bank of England discussed the economics of climate change this year for the first time and have signaled they’ll take account of the government’s environmental goals in buying assets in financial markets.

• The BOE also started a major stress test of the country’s biggest banks and insurers to judge how resilient they are to climate change.

• Sweden’s Riksbank has cleansed its reserves of assets tied to pollution, and started mapping the carbon footprint of its corporate bond purchase program this year. Proposed legislation calls on the bank to consider how its asset purchases can contribute to fighting climate change.

• The U.S. Federal Reserve joined the NGFS in December and is looking at the impact of climate change through the lens of its duty for financial stability. Chair Jerome Powell’s view that global warming isn’t a primary factor for monetary policy has been challenged by his European peers.

• The European Central Bank is considering climate change in its strategy review, launched in January 2020. Consensus is building to tilt bond-buying toward greener assets to protect its balance sheet from climate and transition risks, though disagreements remain over whether policy makers should redirect financing for political reasons.

7. Why has it taken so long?

Central banks generally aren’t able to create new laws or regulations except within their mandate. Because they’re supposed to be independent, they also typically avoid delving into political debates. Central bankers aren’t elected, and can only impact economies indirectly via credit markets. Another point often mentioned by critics is that because the time horizon for monetary policy is about two to three years, and climate change time lines are much longer, central banks are ill-equipped to have a meaningful impact. Finally, there were concerns that central banks’ entry into the arena could open the door for more political influence. The Fed was a frequent target of criticism from U.S. President Donald Trump over interest rates, and sought to avoid further clashes with an administration skeptical about climate change.

More stories like this are available on bloomberg.com

©2021 Bloomberg L.P.