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For the last four or five years, the general market attitude towards central bank announcements on climate change has been a kind of bewildered “what are they thinking?” By 2024, this will become frighteningly obvious.
As Larry Fink pointed out in 2021, everyone wants to say that the financial sector should play a major role in combating global warming, but this is actually a pretty strange approach. If the government wants to regulate carbon dioxide emissions, why not regulate carbon dioxide emissions?
If companies that contribute to climate change are slapped with huge fines and forced to close their factories, the problem of driving financial capital away from them is likely to resolve itself.
On the other hand, tinkering with capital adequacy ratios and attempting a three-cushion approach with off-the-green-ball bank shots will drive the business out of the regulated sector and ensure the exclusion of the least ethical companies. It will be. Fully funded by the least ethical investors.
Mr. Fink said:
Keep in mind that when foundations, insurance companies, and pension funds say, “I don’t own any hydrocarbons,” you don’t change the world because someone else does. Please keep it.
To be fair to banking regulators, they are, for the most part, aware of this. The relevant Basel standards state that climate policy needs to be driven by climate reasons, and that regulatory policy only really plays a role when climate risks present themselves as financial threats to the stability of regulated institutions. It’s pretty clear that it’s limited.
Until this year, it was generally assumed across the industry that the biggest such risk was something called “transition risk.” This is the same concept as “orphaned assets.” The idea is that as the economy changes and climate regulations take hold, some industries will no longer survive and investors and creditors will suffer losses.
This is a real risk, and there is evidence that it is actually happening. One of the main arguments in favor of ‘green quantitative easing’ is that without some limit on holdings, there was a clear risk that central banks would become lenders of last resort to thermal coal producers. .
And when the ECB started forcing European banks to prove that they were measuring and taking climate risks into account, they appeared to have discovered something quite pressing and alarming. That means many European banks don’t have accurate maps of flood and wildfire risks.
If all risk management is based on modeling, that is, modeling is based on historical data. Quite significant problems can arise in recognizing risks that are not in the dataset. Because the risk has never occurred before.
In September, regulators finally lost patience and began imposing fines. “Climate risk” is not just a matter of checking off endless disclosures. An important element of this is “preventing the collateral from being burned or washed away.”
But, of course, it is not only private banks that operate on historical data and are susceptible to unprecedented risks. This is also the basis for inflation targeting, as ECB member Frank Elderson pointed out in a recent speech.
In addition to reducing stocks of natural and physical capital due to climate and natural disasters, they also negatively impact the economic yield of this capital.
To name just a few examples, frequent extreme weather events have reduced crop yields. ECB staff estimates that a heat wave in 2022 will push up overall food price inflation by about 0.6 to 0.7 percentage points, with an impact that will last until 2023.
At this scale, this becomes a risk factor for overall price stability, especially as extreme weather events become more frequent and prolonged. This is why our recent Monetary Policy Communication explicitly acknowledged adverse weather conditions as a risk factor to the inflation outlook.
Economies that are highly dependent on supply chains may also be vulnerable to fires and floods, and whether deviations from targets represent forecast differences that monetary policy needs to address or whether they are unforeseen It will become increasingly important to know whether this is the case. Temporary spikes caused by critical infrastructure being hit by extreme weather.
It is also entirely unsurprising that in a few years, a significant portion of Monetary Policy Committee discussions will be dominated by discussions of how economic forecasting models will interact with forecasts for the next flood and wildfire season. It’s not possible.
It would, oddly enough, bring meteorology back into central banking. The Threadneedle Street meeting room, where Bank of England MPC meetings are held, has a sort of clock on the wall, linked to a weathervane on the roof. It used to be important for the Bank of England’s courts to know which way the wind was blowing, as the number of ships in the Port of London affected the market for bills of exchange.
In the new world, central banks may need a chief hydrologist alongside their chief economist.
