Beyond Data: A Macroprudential Policy to Break the Tragedy of the Horizon

This op-ed was first published in the French journal Alternatives Economiques, with the title Changement climatique: le besoin d’une politique macroprudentielle pour briser “la tragédie de l’horizon”.

Ten years ago, in his speech Breaking the Tragedy of the Horizon, Mark Carney, then Governor of the Bank of England – and now Prime Minister of Canada – issued a warning: climate change is ‘imposing a cost on future generations that the current generation has no direct incentive to fix.’ The reason: these costs were well beyond the horizon of responsibility of those who could make decisions to avoid them at the time. 

Mark Carney was right about one thing: the ecological transition, essential to contain these costs, has fallen too far behind in the last ten years. Despite real progress in renewable energies, billions invested in clean industries and the beginning of a decline in greenhouse gas emissions in some regions, experts now consider it highly unlikely that the Paris Agreement will be met and global warming limited to 1.5°C above pre-industrial levels. This 1.5°C has already been reached, with no sign of slowing down. 

Economic losses, on the other hand, did not take a generation to make themselves felt. The overall costs of extreme weather events are difficult to assess, but most estimates show that they have at least doubled in ten years. 

Economists, including Mark Carney at the time, rightly emphasised, and continue to emphasise, the central role of financial markets in achieving the climate objectives of international agreements. They are indeed essential for mobilising and allocating the capital needed for the transition to decarbonised economic growth – a transition envisaged as gradual but sustained at the time. 

The solution recommended by the then Governor of the Bank of England was to provide markets with much more information on the transition’s costs and opportunities, and how companies were preparing for it. In his view, this would be enough for markets to naturally direct capital towards the investments needed to make the transition successful. 

Since then, national, regional, and international financial supervisors and regulators have stepped up their efforts to improve information on financial institutions’ and companies’ exposure to climate-related financial risks and on how they manage those risks. The availability and quality of such data have improved significantly. 

However, this increased visibility has not produced the expected results. Numerous recent reports highlight that these risks have not diminished, particularly because financing for the transition is significantly behind schedule. Despite significant growth in sustainable finance and investment in renewable energies, notably in France, public and private capital devoted to the transition remains insufficient. At the same time, the expansion of non-renewable energies continues to be heavily financed. For example, the six largest French banks financed fossil fuels with nearly $215 billion over the past four years. Simply put, financial markets are not on a path compatible with international climate objectives. 

The delay in financing the ecological transition has significantly increased the risks that climate change poses to the financial sector’s stability — risks that all financial supervisory and regulatory authorities are mandated to prevent. Central banks have repeatedly warned that failure to transition is the worst-case scenario for financial stability. They have also emphasised that a rapid ‘last-minute’ transition, which is now necessary to avoid this, would entail significant economic and financial risks. 

Faced with the worsening of these risks over the past decade, financial supervisors and regulators must step up their efforts. Experience shows that improved data availability alone does not lead to a significant reduction in these risks. It must be complemented by proactive macroprudential policy to reduce them significantly. 

Such macroprudential policy is within reach. It is based on a holistic view of risks and their long-term management by financial supervisors and regulators, particularly banking supervisors and regulators. It requires effective macroprudential instruments capable of absorbing potential losses linked to increasingly frequent climate events and encouraging financial institutions to finance investments that reduce these risks, particularly those supporting the ecological transition. 

Several concrete proposals are moving in this direction. They range from targeted tools, such as aligning bank capital requirements with climate risk reduction, to broader recommendations, such as the adoption and implementation of transition plans by financial institutions, or better assessment of their real impact on transition financing. The common objective of these measures is to assess and encourage the contribution of financial institutions to mitigating climate risks, and therefore risks to financial stability. They are fully justified as part of sound macroprudential policy, ensuring the long-term stability of the financial system. 

Data accumulation, a solution advocated ten years ago, is not sufficient to fully guide the markets’ financing of the ecological transition. Effective macroprudential policies must complement it to reduce the climate risks to which financial institutions are exposed globally. 

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