Paris - Banque de France, 11 February 2021
The role of central banks in the greening of the economy
Speech by François Villeroy de Galhau,
Governor of the Banque de France
Press contact: Mark Deen (mark.deen@banque-france.fr), Déborah Guedj
(deborah.guedj@banquefrance.fr
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I would like to welcome you to the Banque de France for this 5th edition of the
Rencontres on "Climate Change and Sustainable Finance", organised jointly
with Option Finance. Central banks' commitment to the climate cause may seem
obvious today, and this despite the urgency of addressing the Covid pandemic.
But it was not the case five years ago, and few issues have seen such a rapid
and massive change in mindset and initiative. At the Banque de France and
increasingly within the Eurosystem, we are driven by a simple but tenacious
ambition: to do our utmost to support and add to the collective action in the fight
against global warming. We cannot do everything - nothing will replace an
appropriate carbon price and therefore, let me be clear, a carbon tax in one form
or another. But we can do a lot. The Banque de France spearheaded the
creation of the Network for Greening the Financial System (NGFS), which was
launched in Paris in December 2017 and is chaired by our Dutch colleague
Frank Elderson. This network - which has already achieved a lot regarding the
supervision of banks and insurance companies - now counts more than 80
members, including the US Federal Reserve since 15 December 2020.i Since
2019, the Banque de France has also been the first Eurosystem central bank to
publish a full report on its responsibleii investment policy; we are committed to
completely exiting coal by 2024. Our European Central Bank, for its part, has
been, under the leadership of Christine Lagarde, the first central bank to include
the fight against climate change in its strategic review.
Today supervision, responsible investment, support to green finance, which
Bruno Le Maire has just forcefully stressed... and tomorrow the greening of
monetary policy itself: this morning, I would like to explore together with you
this new frontier that lies before us. It is perhaps the least obvious one, but one
of the most important. The journey will sometimes be a little technical - I agree
- but the roadmap will be all the more precise. I will first come back to the
meaning of our monetary action in the face of climate change (I). I will then
present three concrete levers for acceleration (II).
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***
I. Why must the Eurosystem act on climate change?
Should monetary policy be "greened"? The subject easily gives rise to heated
debate: on the one hand, there are the "conservatives" - not to mention the
climate sceptics - who are concerned only about central banks' action against
inflation, and denounce the risks of "politicisation" and "mission creep". And on
the other hand, there are the activists who are calling for a change of mandate,
with a focus on the fight against climate change and the conversion of
instruments - including the American movement for a "Green QE". In my opinion,
the truth is simpler and stronger. The Eurosystem's consideration for climate
change is neither an abuse of its mission, nor a mere militant conviction or a fad;
it is an imperative that we must pursue in the very name of our current mandate
and to ensure the smooth implementation of monetary policy.
1.1 In the very name of our mandate
Without even having to mention our "secondaryiii" objectives, which include
environmental protection, climate change is linked to the core of the
Eurosystem's monetary mandate: price stability. Shocks related to climate
change are potentially difficult to manage for central banks because of their
stagflationary nature, as they may result in both upward pressure on prices and
a slowdown in activity. Transitional policies - which bring about taxation
changes, such as a carbon tax, or regulatory changes - can affect prices, notably
energy prices, generate inflationary pressures and weigh on activity, as is
already the case in the automotive sector. In addition to transition risks, climate
events are already having increasingly visible effects on activity and food prices.
The price of wheat has currently reached a historic high, partly for climate
reasons. In Europe itself, the drought in the summer of 2018 had caused the
Rhine to drop to a historically low level and slowed growth in Germany by
disrupting river transport.
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In the longer term, climate change will weigh on the potential growth of our
economies. Numerous studies show that higher temperatures reduce labour
productivity by about 2% for every degree above 25°C.iv According to
simulations by the Banque de France, real GDP in Europe is expected to be 2 to
6% lower in 2050, in the event of a disorderly rather than orderly climate
transition.
1.2 For the smooth implementation of monetary policy
Climate risk is also a source of financial risk. It is therefore essential, as my
colleague and friend Jens Weidmann, President of the Bundesbank, says, that
"central banks [...] practice what they preach"v for the banks they supervise, i.e.
better factor climate risk into their own operations. Moreover, preserving financial
stability is a prerequisite for ensuring the smooth transmission of monetary
policy, as the NGFS also recently recalled.vi
Let's face it: the ECB's balance sheet is "exposed" to climate risk through the
securities it purchases and the assets pledged as collateral by banks, to an
extent that is insufficiently taken into account. This is primarily due to the lack of
comprehensive and standardised information that is needed for all economic
agents to factor in climate risk. I will come back to this need for standardisation
later. But more fundamentally, the difficulties in pricing climate risk are due to the
very characteristics of these risks, and in particular to what we call "green
swans", which generate radical uncertainty and whose consequences can be
systemic.vii In this respect, market neutrality - which guides the execution of our
market operations - should not put a brake on carbon neutrality.viii Market
operations are conducted in a neutral manner as long as they comply with the
central banks' risk control rules. And yet, climate risk is precisely a financial risk
that is currently insufficiently measured by markets.ix
Another difficulty is often put forward, but it can be overcome: the fact that climate
risk is long-term, while many of our risk measures are short- to medium-term.
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This is a real technical challenge: the "probability of default" is usually one year;
our economic forecasts cover a two to three-year horizon. We must therefore
work to "lengthen" our measures, but the fact that a "tragedy of the horizonx"
exists is not a call for a status quo. On the contrary! Climate change calls for
early and resolute action as the benefits of corrective measures will essentially
only be felt in the longer term.
II. How should the central bank intervene?
How can this be concretely achieved? Let me start by stressing a key point: the
Eurosystem's highly accommodative monetary policy is already helping to
finance the transition thanks to very low interest rates and abundant liquidity.
Green investment will have to be very significant, we are aware of this, - with
more than EUR 1,000 billion in public and private investment planned as part of
the European Green Deal;xi but never has monetary policy been so favourable
for achieving this. The greening of the central bank's actions does not therefore
require a further easing of monetary policy, but rather a recalibration of its tools.
By next September, we will decide within the Governing Council on the
conclusions of our "Strategic Review". To contribute to this debate, I would today
like to present our ambitions in the form of a simple triptych: forecast, disclose
and incorporate climate risk.
2.1 Forecast, and therefore model
First ambition: to deepen our understanding of the effects of climate change not
only on prices but also on growth, both over the business cycle and over much
longer time horizons. We are not starting from scratch! Much progress has
Our models already
already been made, notably driven by the NGFS.
incorporate, over a three-year horizon, the effects of tax measures to facilitate
the transition, such as the carbon tax. However, changes in the behaviour of
economic agents are more difficult to take into account, even though - via
expectations - their economic consequences could be felt well before their
implementation. We will also need to further examine the impact of the energy
sector on economic dynamics, particularly on international trade or the valuation
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of certain financial assets. Beyond the monetary policy horizon, it is important
to assess the impact of climate risk on potential growth and its consequences
on the central bank's policy space to achieve its primary objective. I am referring
in particular to the long-term effects of more frequent and more severe extreme
climate events on capital accumulation, the labour market and migration flows.
2.2 Disclose, and, for this, impose our standards
This brings me to our second ambition: imposing transparency on all our
counterparties, not only financial but also corporate, for both collateral and asset
purchase programmes. This transparency is a prerequisite for better risk
assessment. To do so, I believe that the Eurosystem should require issuers to
disclose their climate-related exposures using a metric that needs to be
harmonised. As far as the rating agencies themselves are concerned, we could
decide to only work with those that include climate-related risks sufficiently.
This transparency requirement goes hand in hand with a harmonised
regulatory framework. I repeat, and I regret to say that neither in Europe, nor
even in France, are we today in a position to compare - and therefore to correctly
assess - the heterogeneous data published by financial institutions and
companies. From this perspective, the standardisation of data and the draft
Non-Financial Reporting Directive - which will be discussed this year - for
adoption hopefully next year, under the French Presidency - will be the battle to
be fought in 2021. And it would be unacceptable - at a time when progress on
climate change is moving in the right direction and Europe has won the first
round of climate-related values - for Europe to lose the second round, i.e. that
of measuring these values using standards and published data.
2.3 Incorporate climate risk, into order to reduce it in all of our
operations and in the economy
The third part of our triptych, the very core of our activity, and the most powerful:
reducing our climate risk in concrete terms, through our asset purchase and
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collateral policies. This ambition requires great dexterity; but it is rooted in a
conviction: we have in our hands the tools to move forward, concretely, strongly.
I propose to start decarbonising the ECB's balance sheet in a pragmatic, gradual
and targeted manner for all corporate assets, whether they are held on the
central bank's balance sheet (purchases) or taken as collateral, without
including government securities. There are at least two arguments for such a
priority: 1/ it is very difficult to differentiate between the climate policies of the
euro area countries. 2/ Conversely, non-financial corporations are clearly
identified as players whose activities are the most carbon intensive. Thanks to
their transparency efforts, we now know how to calculate climate indicators for
more than 90% of the value of corporate bonds eligible with the Eurosystem.xii
We also know how to do this for the bank loans of the largest debtors, which are
also the most important in climate terms. The second step would be to extend
the decarbonisation strategy to securities issued by financial institutions. To
achieve this, banks will need to be able to assess their indirect emissions,
generated by the activities they finance.xiii
After determining the scope, the decarbonisation method remains to be defined.
I believe that we should seek to achieve an adjustment of the valuation of all
these assets according to the climate transition risk. This solution has the
considerable advantage of avoiding the threshold effects that would result in
simply excluding certain securities. Ultimately, we will be able to and must
directly measure the additional financial risk associated with climate risk, and
reduce the value of the assets accordingly: this is notably the aim of all the
climate stress test methods that we are now actively working on at the Banque
de France and the ACPR, such as in the framework of the NGFS.
But pending their actual completion, we could choose a good "proxy" for this
financial risk, namely climate alignment; i.e. aligning assets and firms with the
2°C trajectory set by the Paris Agreement. More specifically, the Eurosystem
could use indicators that measure the effort that an issuer makes over a given
period to reduce its carbon emissions compared with its peers in the same
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economic sector. Here, we have most of the data. The most advanced 2°
alignment methodologies, even if they have yet to be finalised, are
advantageous in that they take into account both past efforts and future
commitments to reduce "carbon" emissions over a predetermined horizon. This
sector-specific and dynamic assessment over time provides a greater incentive
and would prevent all issuers in carbon-intensive sectors from being blindly
"punished" (contrary to an exclusion-based approach).
For collateral, this asset valuation adjustment could be directly applied. But our
ambition must equally apply at least as much to corporate bond purchase
programmes. Here, we are obliged to purchase assets at the market price; but
I believe it is possible and desirable to recalibrate the purchase limits per
company (tilting) on the basis of climate criteria. For instance, the Eurosystem
could limit its securities purchases from issuers whose climate performance is
not compatible with the Paris agreement. Conversely, securities issued by
"aligned" companies could be purchased in larger quantities. This approach,
applying to all companies and our Corporate Sector Purchase Programme,
would be more comprehensive than a Green QE, whose quantitative impact
would be lower because it would be targeted at green bonds only.
***
This action programme is ambitious: in the fight against global warming, the
Eurosystem would thus target the direct effects - better conducting its monetary
policy and reducing its own risks - as well as the indirect effects - steering the
behaviour of companies and financial institutions, through its disclosure policy,
as well as its asset purchase and collateral policies. And this programme is
demanding: it requires in-depth work on our macroeconomic models as well as
on the climate assessment of assets. But we can make this decision quickly -
by the end of this year - and then implement it in three to five years. Then the
Eurosystem, together with the European Central Bank, under the impetus
created by Christine Lagarde, and the Banque de France, will be the pioneers
in this global fight. We must do so, in the very name of our mandate.
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However, the central banks alone will not be able to do enough. Let us transform
this fight into an opportunity, that of a combination of fiscal, monetary and
structural policies within the framework of a genuine green policy-mix combining
carbon prices, public investment, sector-specific rules and monetary action.
"The future is not what will happen to us, but what we are going to do. It calls
us, or rather it pulls us to it," said Bergson. There is still time to prove him right.
i
On 15 December 2020, the Federal Reserve Board announces it has formally joined the Network of Central
Banks and Supervisors for Greening the Financial System, or NGFS.
ii
Responsible Investment Report of the Banque de France 2019, June 2020.
iii
Article 3 of the Treaty on European Union.
iv
Seppänen et al. (2006), « Room Temperature and Productivity in Office Work », LBNL-60952, Lawrence Berkeley
National Laboratory, Berkeley, CA. ou Niemelä et al. (2002), « The effects of air temperature on labour
productivity in call centres - a case study », Energy and Buildings 34(8), 759-64.
v
Weidmann, J. (2021), "What role should central banks play in combating climate change?", Remarks at the ILF
conference Green Banking and Green Central Banking: What are the right concepts?, Goethe University
Frankfurt, 25 January.
vi
NGFS (2020), "Survey on monetary policy operations and climate change: key lessons for further analysis".
vii
Bolton, P., Després, M., Pereira da Silva, L., Samama, F., Svartzman, R. (2020), "The green swan: central banking
and financial stability in the age of climate change", Bank for International Settlements and Banque de France.
viii
Objective defined in the Paris Agreement signed by 195 countries, of which the European Union.
ix
Schnabel, I. (2020), When markets fail - the need for collective action in tackling climate change, Speech at the
European Sustainable Finance Summit, Frankfurt am Main, 28 September 2020
x
Carney, M. (2015), Breaking the tragedy of the horizon - climate change and financial stability, Speech at
Lloyd's of London, London, 29 September 2015.
xi
Communication from the Commission to the European Parliament, the Council, the European Economic and
Social Committee and the Committee of the Regions; The European Green Deal Investment Plan, 14 January
2020.
xii
Securities eligible as collateral or for purchases under the CSPP.
xiii
Scope 3 carbon emissions