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Global warming Is a Central Bank issue

Central bankers have been dubbed "masters of the universe" for the tools and powers they have acquired since the financial crisis. Some of them now want to play a more active role in the fight against climate change.

Monetary authorities are right to be mindful of the way in which climate risk affects their mandate to ensure price stability and guard financial stability. But that is different from seeking to promote the shift to a "greener" economy, which is the role of government.

Last week, central bank governors from the U.K., France and the Netherlands met in Amsterdam to discuss how to adapt regulation to the risks posed by climate change. Together with five other institutions (from China, Germany, Mexico, Singapore and Sweden), these central banks have formed the "Network for "Greening the Financial System" (NGFS). This group has two objectives: sharing and identifying best practices in the supervision of climate-related risks, and enhancing the role of the financial sector in mobilizing "green" financing.

The first is entirely reasonable and consistent with the central banks' traditional role. As Francois Villeroy de Galhau, governor of the Bank of France, said in a speech at the conference, "Climate stability is one of the determinants of financial stability." It is only right that financial supervisors take an interest in what is going on.

The clearest example concerns the regulation of insurers: Climate change has made extreme weather events such as hurricanes more frequent. Regulators must ensure that the industry updates its models and sets aside enough capital to deal with these growing climate-related risks.

To do so, central bankers may need to extend the supervisory horizon beyond their usual time span. Climate change may only pose a threat for the balance sheet some years down the road, but these risks should be assessed now. Villeroy de Galhau argued in his speech that the financial sector should move towards "a compulsory transparency requirement," so that companies are forced to provide a snapshot of their climate-related risks. It's an idea supervisors around the world should embrace.

The idea that central banks should promote "green investment" -- which the central bank group also endorses -- is more problematic. For a start, the goal could conflict with the main central bank objective of preserving financial stability. For example, if a bank loan to a company which produces renewable energy is given a lower risk weight than now just because it is "green," then supervisors would be giving banks the wrong incentive to load up on such assets. To his credit, Villeroy de Galhau said he would be against giving "green" assets a lower risk weight when establishing capital requirements -- though it's an idea which the European Commission is currently looking at.

But the French central banker said he would be in favor of giving higher risk weights to "brown assets," which contribute to polluting the environment. He added that these could be included in the so-called "Pillar 2" requirements -- which are set independently by supervisors. This plan would make "brown" assets dearer to hold in relative terms, but would not change the risk weight which is attached to "green" assets. The idea is that "brown" assets would become riskier as the world moves towards a low-carbon economy.

The problem with this idea is that it requires more speculation than central banks should be tasked with. What if this shift to a low-carbon economy happens more slowly than anticipated or does not happen at all? Another problem is deciding where to draw the line when it comes to central banks nudging economic actors along: Should central banks also then impose higher capital charges for loans to the gun industry just because they expect that at some stage there will be curbs in a country such as the U.S.?

In "promoting green investment" a central bank would risk overstepping its mandate. By choosing to treat bank loans differently depending on their green credentials, a central bank could also be accused of distorting competition in the economy. 

This accusation would be particularly dangerous given the backlash central banks are facing. Over the last decade, monetary authorities have pushed their toolkits to the extreme. As a result, they have come under closer scrutiny from voters and politicians, who have questioned their independence and demanded greater accountability. The last thing central bankers need now is to suggest they are seeking to influence policy that should rightly be the preserve of elected officials.

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