Markets, Financial Institutions and Central Banks in the Face of Climate Change: Challenges and Opportunities

Abstract

Climate change and the transition to a low-carbon economy involve the financial system in two ways. First, because it channels the funds needed to make the large investments to comply with the Paris Agreement. Recent years have seen headway, albeit insufficient, in the development of new products, of which green bonds are the most advanced green financing instrument. Second, because of the financial risks associated with climate change and the transition to a low-carbon economy, which affect financial institutions’ balance sheets and are, moreover, systemic. This means that financial institutions have to assess these risks and their exposure to both of them, although it is not an easy task. There are still obstacles and challenges to overcome, such as the lack of a complete taxonomy that comprises what is “green” and what is not green, the lack of information on and knowledge of appropriate methodologies, and the long and uncertain time horizon of these risks, which calls for rolling out new skills and integrating these risks in the whole of the organisation, as well as taking a forward-looking approach. Lastly, central banks’ responsibilities regarding bank supervision, financial stability, asset management and monetary policy also make it necessary for them to analyse the potential systemic implications they may have for the economy and the financial system as a whole in order to incorporate climate-change issues into their supervisory and macro-prudential practices, into the portfolio management of their own portfolios, and, within their mandates, in their monetary policy framework. The progress made in recent years by financial markets, financial institutions and central banks has been significant although there is still a way to go.

Keywords: climate change, financial risks, financial stability, green bonds, central banks, sustainable finance

JEL Classification: G10, G20, E58, Q50