November 27, 2022
Bank of Japan
Climate Change and Finance
Speech at the Japan Society of Monetary Economics
AMAMIYA Masayoshi
Deputy Governor of the Bank of Japan
Introduction
It gives me great pleasure to have this opportunity to speak to you today at the Japan
Society of Monetary Economics.
Today, I would like to talk about climate change and finance. Addressing climate change
has become one of the most important policy issues both internationally and at home. In
corporate activities as well, addressing environmental, social, and governance (ESG) issues,
including climate change, is an important management issue. The world of finance is also
taking steps to address climate change. When making investments and loans, financial
institutions increasingly consider whether they contribute to addressing climate change. In
addition to shareholders, a wide range of stakeholders, including organizations,
non-profit
are demanding that financial institutions take climate change issues into account.
Climate change and finance have become increasingly linked in recent years in both policy
and practice. In my speech today, I would like to first consider the basic issues related to
climate change and finance, and then provide an outline of the efforts and initiatives of
private financial institutions and central banks around the world, including the Bank of
Japan. Finally, I would like to talk about some of the related challenges in financial and
economic analysis, with a sincere request to all researchers for further research
development.
I. Basic Issues Related to Climate Change and Finance
I would like to start by considering some basic issues related to climate change and finance.
Please refer to Slide 1. One issue is why finance plays an important role in addressing
climate change. Another issue is how climate change affects finance, in particular the
financial system.
Importance of Finance in Addressing Climate Change
One way in which economics approaches climate change issues is through the concept of
"externalities." In economics, when individual firms and households make economic
decisions, they are assumed to do so based on the prices they face. However, the negative
impact of associated greenhouse gas emissions on society is not necessarily reflected in
those prices, resulting in excessive greenhouse gas emissions. To address these
"externalities," an important role falls to fiscal policy, including the tax system such as
carbon taxes and the provision of subsidies for investments that contribute to
decarbonization, and regulations. However, to achieve net zero emissions, massive amounts
of investment capital are required for business fixed investment to substantially increase the
amount of electricity generated from renewable energy sources and for promoting
innovation. The Glasgow Financial Alliance for Net Zero (GFANZ) has estimated that the
world will need to invest $125 trillion to achieve net zero by 2050. In order to raise such
huge amounts of investment capital, funding through financial institutions and financial
markets has an important part to play in implementing investments to achieve net zero. As I
mentioned earlier, not only are stakeholders such as shareholders demanding that financial
institutions take climate change issues into account in their actions, but financial institutions
themselves are also taking proactive steps, seeing the growing demand for funds to achieve
net zero as a business opportunity. Moreover, for the vast amounts of funds to be used
efficiently, it is essential that financial institutions and investors in financial markets choose
investments carefully, appropriately assessing the risks and returns to ensure that funds are
allocated efficiently. In addition, it is necessary to establish mechanisms that allow external
stakeholders to closely monitor the appropriateness of the use of such funds. In this regard,
an important issue is the enhancement of disclosures by firms and financial institutions.
Enhanced disclosure helps to impose discipline on firms' and financial institutions'
investment and financing activities through market pressure. Strengthening the voluntary
efforts of firms and financial institutions through the discipline of disclosure represents a
step toward "internalizing" the "externalities" of climate change into the market mechanism.
Impact of Climate Change on the Financial System
Next, I would like to consider how climate change will affect the financial system. In
assessing the impact of climate change on the financial system, two types of risks need to be
considered: physical risks and transition risks. "Physical risks" refer to risks that physical
phenomena such as major disasters and rising sea levels caused by climate change will lead
to losses for firms and households. "Transition risks" refer to risks that changes in policies,
technologies, and consumer preferences associated with the transition to net zero will have
an economic impact on firms and households. If the transition to decarbonization is delayed,
"physical risks" will materialize, increasing the likelihood that natural disasters will trigger
losses at financial institutions' borrowers. On the other hand, when the transition to net zero
makes progress and financial institutions' existing borrowers are, for example, firms that
emit a lot of carbon, the value of those borrower firms' assets will deteriorate. In both cases,
the quantity and quality of financial institutions' investment and loans changes, which --
depending on the response could have a negative impact on the financial system.
--
Therefore, addressing climate change issues has also become an important factor in terms of
the management of financial institutions and the stability of the financial system.
II. Efforts by Private Financial Institutions
Next, I would like to discuss efforts by private financial institutions. As I mentioned earlier,
private financial institutions have accelerated their efforts to address climate change in
recent years. In this context, I would like to introduce two examples of
cross-border
cooperation and initiatives by financial institutions. Please refer to Slide 2. One example is
GFANZ, a global voluntary alliance of private sector financial institutions that was formed
last year. The alliance currently has more than 550 members, comprising a wide range of
financial institutions, including banks, insurance companies, asset managers, institutional
investors, etc., that discuss concrete measures in alliances. Member financial
sector-specific
institutions are required to develop individual plans toward net zero and publish relevant
information. At last year's COP26, GFANZ members announced that a total of $100 trillion
in investment and loans was committed to transforming the economy for net zero over the
next three decades. As I mentioned, GFANZ has estimated that the world will need to invest
approximately $125 trillion to achieve net zero by 2050. Therefore, it is important that
financial institutions, including GFANZ members, hammer out active and concrete
investment and lending policies in order to ensure that private financial institutions are able
to fully finance the investment and loans needed to transition to decarbonization. In this
context, there is growing recognition of the importance of transition financing. In June this
year, GFANZ released a document on transition planning.1 In its recommendations
net-zero
and guidance for financial institutions, GFANZ has positioned a "managed phaseout of high
1
"Towards a Global Baseline for Net-zero Transition Planning," GFANZ, June 2022.
emitting assets" as one of the pillars of the transition to net zero and emphasized the
importance of transition financing.
Another effort by private financial institutions that has grown in influence in recent years is
the Principles for Responsible Investment (PRI). This is an international group of
institutional investors, formed at the initiative of the United Nations, that currently has
about 5,000 participating institutions. Signatory institutions are required to take ESG factors
into account in their investment decisions and report on their activities and progress toward
implementing the principles. It is expected that institutional investors actively encourage
firms that they invest in to move toward decarbonization.
III. Initiatives by Central Banks
Recent Developments
I would now like to discuss initiatives by central banks. Last year, the Bank of Japan
established an internal organization, the "Climate Coordination Hub," to strengthen its
climate institutional setup, released the "The Bank of Japan's Strategy on
change-related
Climate Change," and decided to implement a variety of measures.2
Initiatives are also underway at central banks overseas. The first to launch a comprehensive
climate change initiative was the Bank of England. Similarly, the European Central Bank
(ECB) decided an action plan last year. Meanwhile, the U.S. Federal Reserve established
two committees last year to examine the implications of climate change for financial
institutions and the financial system from a and a macroprudential perspective,
micro-
respectively.
Information sharing and cooperation among central banks on climate change issues is also
making progress. The Network of Central Banks and Supervisors for Greening the Financial
System (NGFS) was launched in 2017 as a forum for central banks and financial
supervisors to discuss how to address climate change. The Bank of Japan joined in 2019,
2
https://www.boj.or.jp/en/announcements/release_2021/rel210716b.htm/.
The Bank's website also provides a page with a list of links to information on the Bank's various
activities with regard to climate change. See: https://www.boj.or.jp/en/about/climate/index.htm/.
participating in discussions on the impact of climate change on the economy and the
financial system. Based on the view that scenario analysis reflecting possible future climate
conditions is useful for examining the risks to the financial system, the NGFS published a
set of basic scenarios in 2020, which have subsequently been updated from time to time.
Several central banks and financial supervisory authorities are currently conducting
analyses of their financial system based on the NGFS scenarios. Climate change is also one
of the central topics of discussion at the G7 and G20. Concretely, discussions include the
promotion of corporate disclosures based on the TCFD recommendations, the design of
disclosure standards by the International Sustainability Standards Board (ISSB), and the
importance of financial system analyses. The Executives' Meeting of East
scenario-based
Central Banks (EMEAP), a gathering of Asian and Pacific central banks, has
Asia-Pacific
also discussed the impact of climate change. Asia accounts for about half of the world's
carbon dioxide emissions and is also the region most vulnerable to flooding and other
adverse effects of climate change. Asian policy makers therefore have strong interest in
addressing climate change.
I would now like to turn to two topics central banks' mandate and market neutrality that
-- --
are important issues for central banks in addressing climate change issues, and then discuss
the Bank's specific initiatives, while also touching on the efforts of other central banks.
Please refer to Slide 3.
Basic Concept 1: Central Banks' Mandate
I would like to start by considering central banks' mandate and the response to climate
change. Central banks in many countries, including Japan, are responsible for price stability
and the stability of the financial system. Since I already highlighted the importance of
climate change issues to the financial system earlier, let me here talk about price stability.
As I mentioned at the outset, increases in the frequency of disruptions to economic activities
due to the loss of basic social infrastructure and in supply chain disruptions have been
observed in recent years as a result of the growing scale and frequency of natural disasters
worldwide due to the effects of climate change. These disruptions increase the volatility of
real economic activity, which in turn leads to price fluctuations. In addition, there are
concerns over swings in fossil fuel and other energy prices and their impact on other goods
and services prices if the transition to net zero does not proceed smoothly. Therefore, if
central banks' actions can help to smooth the transition to net zero, this will contribute to
price stability in the medium to long term.
Thus, climate change may have an extremely large impact on the economy, prices, and
financial conditions over the medium to long term. Therefore, from the standpoint of central
banks, which are responsible for price stability and the stability of the financial system,
supporting the private sector's response to climate change will contribute to macroeconomic
stability in the long run.
Basic Concept 2: Market Neutrality
Next, I would like to talk about the response to climate change and market neutrality. Let
me start with the basic concept of market neutrality. Central banks' actions affect society
and the economy in many ways. The key principle in this regard is that the central bank
should work on the macroeconomy as a whole while intervening as little as possible in the
microeconomic allocation of resources. For example, central banks need to avoid making
judgements about individual economic activities and financings to determine which are
"brown" and which are "green." This raises the question in what form the central bank
should take an active role in the response to climate change issues. If investment and
lending decisions in the private sector were made without taking the negative externalities
of greenhouse gases into account, actions with respect to investments and
market-neutral
loans currently implemented would preserve a resource allocation that is biased toward
"brown" industries compared to what is socially desirable. On the other hand, if
investments and loans were made taking the negative externalities of
private-sector
greenhouse gas emissions into account, central bank asset purchases and
funds-supplying
measures in line with those investment and loan portfolios would be more
private-sector
neutral toward the transition to net zero. Moreover, as mentioned earlier,
private-sector
firms and financial institutions are currently trying to internalize the negative externalities
by becoming more proactive in addressing climate change. From a
forward-looking
perspective, supporting such developments would preserve market neutrality.
Based on these considerations, I would next like to outline the Bank's specific measures.
Monetary Policy
Last year, as one of its monetary policy measures, the Bank introduced a new
measure, the Climate Response Financing Operations, through
fund-supplying so-called
which it provides funds to financial institutions for investments or loans that they make to
address climate change based on their own decisions. Please see Slide 4. In principle, these
Climate Response Financing Operations will be conducted twice a year, and funds were
provided in December of last year and July of this year. Currently, 63 financial institutions,
including regional financial institutions, are eligible for such funds, and the total
outstanding balance of loans disbursed by the Bank is 3.6 trillion yen. Participating
financial institutions are required to demonstrate their efforts to address climate change by
disclosing information in the four thematic areas in the TCFD recommendations
(governance, strategy, risk management, and metrics and targets) as well as targets and
actual results for their investments or loans. On the other hand, to maintain market
neutrality mentioned earlier and avoid involvement in the allocation of resources at the
micro level, the Bank does not check individual investments and loans made by financial
institutions. Thus, the setup of the Climate Response Financing Operations is that they
support investments and loans to reduce carbon emissions through the provision of funds,
while making use of the disclosure mechanisms as well as financial institutions' expertise in
selecting investment and loans.
Meanwhile, the ECB has decided to change the way it purchases corporate bonds and treats
collateral so that, based on certain rules, it takes into account the impact of climate change.
In Europe, a taxonomy and corporate reporting standards on sustainability have been
established, and the ECB's corporate bond purchases and treatment of collateral take these
standards into account.
In Japan, on the other hand, the discussion on standards and taxonomies with regard to the
response to climate change is still in flux. Therefore, under the Climate Response Financing
Operations, it is financial institutions that make the decisions on which investments or loans
contribute to addressing climate change, so that they can respond flexibly to firms' funding
needs. In addition, the setup aims to impose market discipline by requiring financial
institutions to disclose a certain level of information on their efforts to address climate
change. Moreover, since financial intermediation in Japan is mainly based on indirect
financing, the Climate Response Financing Operations, which provide funding for
investments and loans that contribute to decarbonization via banks can be regarded as the
most effective way to provide financial support not only to large corporations but also to
small and medium-sized enterprises in their efforts to achieve net zero.
In the process of conducting the Climate Response Financing Operations, financial
institutions have commented that the operations have provided them with an opportunity to
enhance their own disclosure and that they have been able to enter a dialogue with their
customers on business fixed investment to reduce carbon emissions. The Bank hopes that
these operations will continue to work as a kind of catalyst and provide a push to efforts to
reduce carbon emissions in Japan.
Financial System
Next, I would like to talk about the response of the financial system. In pushing ahead with
the transition to net zero, it is important that the proper functioning of financial
intermediation is maintained. The Bank seeks to ensure the stability of Japan's financial
system and the smooth functioning of financial intermediation by appropriately monitoring
the situation and actively supporting financial institutions' efforts to identify and manage
financial risks.
climate-related
As mentioned earlier, climate change issues can have a significant impact on the business
conditions of financial institutions, and hence on the stability of the financial system,
through physical risks and transition risks. Please see Slide 5 for more details on the
transmission channels. When physical risks and transition risks associated with climate
change materialize, they can have a substantial impact on the real economy through the
disruption of business, a decline in asset values, and a rise in energy prices. These adverse
effects on the real economy will impact the financial system through a decline in the value
of assets and an increase in credit costs.
Therefore, it is important for financial institutions to conduct appropriate risk management
based on the impact of climate change. However, a key feature of climate change issues is
that they are difficult to incorporate directly into existing risk management frameworks. The
time horizon over which risks may materialize is extremely long and uncertain, and the data
necessary for risk management do not exist. How to deal with these issues represents an
urgent challenge not only for financial institutions but also for central banks and financial
supervisory authorities.
Against this background, scenario analysis is currently attracting attention worldwide as one
approach to quantitatively understand the impact on financial institutions and financial
systems in the event that risks materialize. This approach involves assuming
climate-related
hypothetical scenarios that include greenhouse gas emissions, carbon prices, global average
temperatures, as well as the corresponding paths of macro and economic
industry-level
variables, and then measuring the corresponding credit and market risks for each scenario.
The scenarios are created using, at their core, the integrated assessment models developed
by Professor Nordhaus of Yale University, winner of the Sveriges Riksbank Prize in
Economic Sciences in Memory of Alfred Nobel 2018. Moreover, a number of risk models
that have been used extensively in the field of finance are also employed to measure risk.
While scenario analysis employs essentially the same methodology as conventional stress
tests conducted to check the resilience of financial institutions and the financial system to a
substantial downturn in the economy, it differs in several respects. First, there are large
differences in the availability of data and the econometric models. Conventional stress tests
are based on data such as data of past business cycles and, building on previous analyses,
can be performed with a reasonable degree of reliability. On the other hand, there is still
insufficient data on climate change and related economic and financial variables, and there
are no established integrated assessment models or risk measurement methods. Moreover, it
has been pointed out that if climate change is not addressed, humanity will face
unprecedented circumstances, and the negative economic impact may increase in a
nonlinear fashion; however quantitative analysis of this is fraught with difficulties. The
second difference concerns the time horizon of the risk analysis. While the time horizon for
conventional stress testing is two to three years, assessing risks requires a
climate-related
quantitative understanding of the situation over a much longer horizon of several decades.
Partly for these reasons, scenario analysis is still in its infancy.
Scenario analysis is now being undertaken in many countries. Please refer to Slide 6.
According to a survey by the Financial Stability Board (FSB) and the NGFS, as of
November 2022, about 40 countries or regions had already conducted or are planning to
conduct scenario analysis. The objectives of scenario analysis include understanding the
impact on individual financial institutions and the financial system as a whole, improving
the analytical capacity of both authorities and financial institutions, and identifying data
constraints. However, in most countries or regions, the use of scenario analysis is still at the
trial stage.
In Japan, the Bank of Japan and the Financial Services Agency (FSA) jointly conducted a
pilot scenario analysis exercise with major financial institutions last year, with the results
released in August this year.3 The pilot exercise was not intended to provide a quantitative
assessment of the impact of climate change on these major financial institutions. Rather, it
was intended to serve as a means to continuously improve and develop analytical methods
of the scenario analysis and focused on understanding data constraints, assessing the
validity of analytical assumptions and methods, and identifying issues for future
improvement and development. Specifically, the Bank and the FSA prepared scenarios
based on those provided by the NGFS and let the major financial institutions conduct risk
analyses of these scenarios using their own models. The results of the analysis showed that
the major financial institutions had their own frameworks in place to perform risk analysis
for various scenarios. On the other hand, they also showed that there was considerable
variation in the risk measurement results due to differences in the data and measurement
models used by the major financial institutions. This variation reflects the lack of data
necessary for the analysis as well as the substantial uncertainty surrounding issues such as
technological developments and client firms' behavior. Going forward, the Bank intends to
further improve the sophistication of the scenario analysis by deepening its dialogue with
financial institutions, taking the issues identified in the pilot exercise into account.
In addition, in its examinations and offsite monitoring, the Bank makes efforts to
on-site
continue its dialogue with financial institutions on their responses to
in-depth
3
The results can be found here:
https://www.boj.or.jp/en/announcements/release_2022/rel220826a.htm/.
financial risks and their support for client firms' efforts toward net zero.
climate-related
Moreover, the Bank also encourages financial institutions to enhance the quality and
quantity of their disclosures based on the TCFD, etc., in light of the revised Corporate
Governance Code.
The "Market Functioning Survey Concerning Climate Change"
To address climate change issues, it is also important that financial markets fulfill their
financial intermediation function. If risks and opportunities arising from climate change are
appropriately reflected in the prices of financial instruments such as stocks and bonds, this
should facilitate funding and investment through financial markets and, in turn, add impetus
to the climate change response. Based on these considerations, the Bank decided to conduct
a periodic survey of financial institutions, business corporations, rating agencies, and others
to ascertain the functioning of climate markets and the issues that need to be
change-related
addressed in order to improve them. The results of the first survey were released in August.4
Please see Slide 7. The main findings were as follows. First, respondents indicated that
although risks and opportunities were incorporated into the prices of
climate-related
financial instruments to some extent, there was still room for them to be incorporated to a
greater extent. Second, with regard to the market for climate ESG bonds,
change-related
such as green bonds, the survey suggested that there was strong demand for ESG bonds.
This appears to be due to the importance investors attach to making a social and
environmental contribution. Third, in terms of issues in expanding the ESG bond market, in
addition to the need to broaden the base of investors and issuers, some respondents pointed
out issues regarding the availability of information and methods for assessing risks and
opportunities. In October, the Bank held a conference call on the survey with about 150
participants from financial institutions, business corporations, rating agencies, industry
associations, etc., to exchange opinions on the survey results and issues to be addressed to
expand the ESG bond market.
Going forward, the Bank intends to continue conducting this survey on an annual basis,
while making efforts to improve its contents, in order to understand the functioning of
4
The results can be found here: https://www.boj.or.jp/en/research/brp/ron_2022/ron220805a.htm/.
climate markets and issues that need improvement, and to contribute to the
change-related
development of these markets through dialogue with relevant stakeholders.
Central Banks' Own Operations
Next, I would like to talk about central banks' own operations, etc. There is a growing trend,
particularly among European central banks, to conduct operations taking the need to
respond to climate change into account. The Bank of Japan, as a business entity, is also
taking steps to address climate change in its operations. Specifically, the Bank began
disclosing information based on the TCFD's recommendations this year. In addition, under
the existing principle that the Bank's foreign currency assets shall be managed with an
emphasis on safety and liquidity, the Bank has been purchasing foreign
green bonds issued by governments and other foreign institutions.
currency-denominated
International Cooperation
Furthermore, it is also important to participate and engage in international discussions on
climate change issues, while closely monitoring developments in these discussions. At
international gatherings such as the G7, G20, and EMEAP, as well as meetings with other
central banks, the Bank collects information on efforts in other countries, explains the
Bank's own measures, and contributes to progress in international efforts to address climate
change by participating in multilateral discussions. With regard to the financial system, the
Bank, in close collaboration with the FSA, has been actively involved in the development of
an international framework for addressing financial risks at forums such as
climate-related
the Basel Committee on Banking Supervision, the FSB, the NGFS, and others. The Bank
has also been cooperating with financial institutions and relevant authorities in international
efforts to compile the data necessary to assess financial risks.
climate-related
As part of its international financial cooperation, the Bank, in cooperation with other central
banks, is strengthening its efforts to promote investment in financial
climate-related
products such as green bonds, with the aim of fostering the development of financial
markets. The Bank has long been investing in the Asian Bond Fund launched by EMEAP
for the purpose of supporting the development of local bond markets
currency-denominated
in Asia. In July last year, in consultation with other EMEAP member central banks, it was
agreed to expand the scope of investment in the Asian Bond Fund in order to catalyze a
further deepening of local-currency denominated green bond markets in the region, and this
has been implemented starting March of this year.
IV. Challenges in the Financial and Economic Analysis of Issues
Climate-Related
Next, I would like to discuss some of the challenges in the financial and economic analysis
of climate change issues based on our experience to date. Please see Slide 8.
First, it is necessary to further develop analytical models. In particular, in order to refine
scenario analyses to examine the economic impact of climate change on financial
institutions and the financial system, it is essential to improve our theoretical analytical
tools and accumulate empirical research. In addition, since climate change will have a
significant impact on macroeconomic activity and prices, it may be necessary to take a
different perspective in terms of theories of economic growth and the analysis of monetary
policy. Last year, the Institute for Monetary and Economic Studies of the Bank of Japan
published a series of special edition newsletters entitled "The Economics of Climate
Change" to provide an explanation of the current state of the economic
easy-to-understand
analysis of climate change. Bank of Japan staff members have also deepened discussions
with relevant experts, for example by actively participating in various study groups. I hope
that the Bank will continue to share its research and practical expertise widely and carry on
with the mutual exchange of ideas between the Bank and academia, and that academia
continues to deepen its analyses of these issues, allowing the Bank to incorporate the
insights obtained into its own work.
Second, the analysis of the financial and economic impact of climate change issues requires
collaboration with experts in the natural sciences. This certainly applies to scenario analysis.
For instance, the extent to which policy responses limit increases in global temperatures and
hence the extent to which natural disasters are prevented is important information for
measuring the economic impact of policy responses. The NGFS, which provides climate
change scenarios to measure future economic risks, is working with climate scientists to
improve the scenarios. Since climate change is both a global issue and at the same time
something whose local impact varies considerably, there is a need for greater cooperation at
the country or regional level between experts in the natural sciences and those examining
the economic impact of climate change.
The third challenge concerns enhancements in terms of financial analysis. Various
investments are needed to achieve net zero. As mentioned earlier, financing through
financial institutions and financial markets is important to achieve such investments. A
crucial aspect in this context is whether financial institutions' loan interest rates and the
pricing of financial instruments adequately incorporate the risks and opportunities
associated with dealing with climate change. The Market Functioning Survey conducted by
the Bank of Japan mentioned earlier also indicated that there was room for risks and
opportunities to be incorporated in s