ECB and Climate Change: The Direction is Clear – But Ambition and Speed are Lacking

This blog is the translation of an article initially published by Makronom (here).

All public institutions urgently need to address the colossal challenges posed by climate change. Central banks are no exception, and their representatives are well aware of this.

Jens Weidmann, President of the Deutsche Bundesbank, for example, is convinced “that we can all do more to mitigate climate change.” His view echoes repeated calls by ECB President Christine Lagarde for central banks to address climate change as a serious threat. Against this backdrop, the ECB has made the impact of climate change an integral part of its ongoing strategic review and is currently in the process of evaluating its initial analysis.

Consensus on mitigating climate risks in the ECB balance sheet

Although the views within the Governing Council on the details vary widely, one point seems to be undisputed: Central banks need to capture and manage the risks associated with climate change on their balance sheets. Climate change brings financial risks. Like all other financial institutions, central banks are exposed to these risks through the securities they purchase and the assets they accept as collateral from banks for their refinancing operations.

Monitoring financial risks and keeping them under control on their balance sheets is a core task of central banks. To achieve this, they must fully integrate climate-related financial risks into their own risk management. As Jens Weidmann emphasized in a speech on climate change last November, “We owe it to European taxpayers to keep the financial risks that arise from our monetary policy operations in check.”

The ECB can and must reduce its exposure to climate risks. François Villeroy de Galhau, the governor of the Banque de France, has repeatedly advocated taking climate risks into account in the valuation of all assets held on the ECB’s balance sheet or taken as collateral.

Why only in “three to five years”?

The direction is clear. What is missing is speed. Villeroy de Galhau’s envisioned timeframe of three to five years for implementing his proposal does not do justice to the urgency of the issue. It is also at odds with the fact that existing climate risk analyses already provide an important complement to existing risk assessments. In this regard, Villeroy de Galhau himself highlights that the ECB can already calculate climate risk indicators for more than 90% of the value of corporate bonds eligible in the Eurosystem, as well as for bank loans of the largest borrowers. Moreover, the ECB expects the banks it supervises to integrate climate risks into their risk management within two years. In this case, the ECB should practice what it preaches for banks in its own operations. And not in five years, but now.

Jens Weidmann’s proposal to limit the eligibility of bonds for purchase or as collateral to issuers that report climate-related risks also falls short. Asking for more data without acting on it would leave the risks on the ECB’s balance sheet unchanged. Or as Andrew Bailey, Governor of the Bank of England, puts it: Uncertainty and lack of data are no excuse for inaction.

Further need for action on environmental objectives

Integrating climate risks into monetary policy operations is a critical first step. Indeed, the ECB’s failure to incorporate climate risk metrics exposes it to undue risks that are inconsistent with sound central bank balance sheet management. However, the need for action goes further.

The ECB’s mandate includes an obligation, without prejudice to the objective of price stability, to support the general economic policies in the Union with a view to contributing to the achievement of the Union’s objectives, which include, inter alia, “a high level of protection and improvement of the quality of the environment.” As ECB Executive Board member Frank Elderson has rightly made clear, this provision, like its entire mandate, is a duty, not an option, for the ECB.

As part of its mandate, the ECB is therefore instructed to take environmental objectives into account in all its instruments to the extent that this can be done without compromising the objective of price stability. This should include, among others, proposals for integrating climate considerations in its asset purchase programs and the collateral accepted for lending operations, as well as into targeted longer-term refinancing operations (TLTROs).

The ECB’s commitment to combating climate change is essential and urgent. It is an integral part of its responsibility to keep the risks on its balance sheet under control. It is essential to safeguard price and financial stability. And it falls within its duty to support economic policy in the Union and its objectives. The challenges we face require ambition and speed. The ECB must act now.