Jens Weidmann: What role should central banks play in combating
climate change?
Remarks by Dr Jens Weidmann, President of the Deutsche Bundesbank and Chair of the Board
of Directors of the Bank for International Settlements, at the ILF Online-Conference "Green
Banking and Green Central Banking: What are the right concepts?", Goethe University Frankfurt,
25 January 2021.
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1 Introduction
Ladies and gentlemen,
I would have been only too happy to meet you all in person. Even more so, as from my office it
would only have been a short walk to the campus of the Goethe University.
And allow me the following side remark: There can hardly be a better person to name a university
after than Johann Wolfgang von Goethe. Goethe combined many disciplines and subjects, and
not just as a poet, dramatist, novelist and critic. He also conducted research in various natural
sciences, studying minerals, plants, human anatomy and meteorology, to name a few. And let's
not forget that he reflected on the nature of money, even serving as finance minister in the Duchy
of Saxe-Weimar-Eisenach, a small, former state in what is now Thuringia. Goethe seems to be a
true all-rounder, able to turn his hand to any number of things.
Some would like to see central banks in a similar role. In their view, not only are we supposed to
ensure price stability, help with supervising banks and safeguarding financial stability, foster
growth or promote employment. Some also expect central banks to act as a rapid response unit
for every economic crisis, keep sovereign financing costs low or provide savers with adequate
interest rates. Recently, another item has been added to the wish list: we are being called upon
to assume an active role in climate policy.
One thing is clear: climate change presents a challenge for all of humanity. The Swiss playwright
Friedrich Dürrenmatt wrote in an appendix to his play The Physicists: "What concerns everybody
can only be solved by everybody." Therefore, every institution is right to ask itself what
contribution it can make to mitigating climate change within the remit of its mandate.
2 Dealing with climate-related risks
The mandates of central banks and financial supervisors vary, but they typically include price
stability, financial stability and the soundness of financial institutions. Climate change and climate
policies can affect all of these mandates, as they may have an impact on macroeconomic and
financial variables such as output, inflation, interest rates and asset prices, while altering the
underlying structure of our economies. It is therefore essential for central banks to gain a full
understanding of these repercussions for the functioning of the economy and the financial
system. We need to embed climate-related developments and risks in our analyses and update
our analytical and forecasting toolkits accordingly.
Regarding the impact on the financial system and the economy, climate change entails both
physical and transition risks. First, physical risks result from persistent changes in climate and
more frequent extreme weather events. Goethe himself experienced first-hand the enormous
impact extreme weather can have. In his day, this was caused by a volcanic eruption far away on
an Indonesian island. The year 1816 went down in history as the "Year Without a Summer".
People suffered from the cold and from persistent rain; crops failed and famine broke
out. Second, transition risks relate to the process of adjustment towards a lower-carbon
economy.
Both the physical impact of climate change and the transition to a less carbon-intensive
economy can be a source of financial risk. For example, the ECB found in a sample of euro area
banks that the exposures to the twenty largest emitters of carbon account for 20% of total large
exposures.
Clearly, it is in every market participant's interest to properly protect themselves against
climaterelated financial risks by adjusting their risk management accordingly. Thus, first and foremost,
it's up to the financial sector to recognise and take into account such risks. Whether and how
this is done has a bearing on several of our tasks as a central bank.
In banking supervision, we do not regard climate-related financial risks as a new risk category,
but as a driver of classic categories such as credit risk and market risk. We already expect
banks to incorporate such risks into their risk management framework appropriately and to back
them with adequate capital.
However, climate-related risks have certain characteristics that hamper their inclusion in ratings
and internal risk models. First, historical data do not capture them adequately. Second, physical
risks are potentially non-linear and expected to primarily materialise in the medium to long term.
And third, the future pathway of climate change and climate action is highly uncertain, not least
because it heavily depends on political decisions.
In this context, scenario analysis is a particularly useful tool. Furthermore, it is important that
banks take a forward-looking approach and consider a longer than usual time horizon. The ECB
Guide on climate-related and environmental risks outlines the supervisory expectations and sets
an ambitious goal: to fully integrate all relevant climate-related risks into banks' risk management,
business strategy and internal organisation.
Every new beginning is difficult. But, to echo the king in Lewis Carroll's "Alice in Wonderland", we
have to "Begin at the beginning." According to a survey conducted by the ECB and the EBA, only
a small number of institutions have fully incorporated climate-related risks into their risk
management framework already. In 2019, the stress test conducted by the Bundesbank and
BaFin for small and medium-sized banks (less significant institutions, LSIs) yielded a similar
result: only one third of the German credit institutions had incorporated climate-related risks into
their risk management at least to some degree. Two-thirds did not take them into account at all.
Clearly, an ambitious goal cannot be reached overnight. However, supervisors do expect
continuous progress to be made. Therefore, addressing climate-related risks will continue
gaining in importance in banking supervision. This year, we will use the supervisory dialogue to
discuss the banks' self-assessments and plans to meet the supervisory expectations. And next
year, the ECB will conduct its supervisory stress test on climate-related risks.
Obviously, central banks are not commercial banks. But our financial assets can be just as
exposed to financial risk as those of commercial banks. In this regard, central banks should
practise what they preach. Hence, I believe that central banks should factor climate-related
financial risks into their risk management. That should also apply to financial risks arising from
monetary policy operations.
For this purpose, the Eurosystem has a legitimate interest in making climate-related financial
risks more transparent: In my view, we should consider only purchasing bonds or accepting
them as collateral for monetary policy purposes if their issuers meet certain climate-related
reporting requirements. In addition, we could examine whether we should use only those ratings
that appropriately include climate-related financial risks.
By taking such measures, the Eurosystem would help foster market transparency and standards
at rating agencies and banks. In this way, we could act as a catalyst for change in the financial
system and support climate policies in the EU without overstretching our mandate.
3 Central banks cannot substitute for stringent carbon pricing
But problems arise when monetary policy, financial supervision or banking regulation are
pressed into service for other purposes. Each of these domains already has a clearly defined
objective. This focus is also consistent with the Tinbergen rule, named after the first Nobel
Laureate in economics, Jan Tinbergen. His rule stipulates that for each separate economic policy
target, there must also be at least one separate instrument.