Frank Elderson: Taking into account climate and nature in monetary
policy and banking supervision around the world
Remarks by Mr Frank Elderson, Member of the Executive Board of the European
Central Bank and Vice-Chair of the Supervisory Board of the European Central Bank, at
an event on climate-related financial risks, hosted by the Central Bank of Brazil, Rio de
Janeiro, 27 March 2024.
* * *
Many thanks to the Banco Central do Brasil for inviting me here today. I am honoured to
be speaking in Rio de Janeiro's botanical garden. It is home to more than 6,500
different species - just a fraction of the more than 130,000 species that are estimated to
be found in Brazil, the most biodiverse country in the world. But even this little glimpse
into Brazil's biodiversity is more than sufficient to appreciate the concept of natural
capital and the tremendous value it represents.
At the same time, global heating and nature degradation are putting this natural capital
at risk. And central banks and supervisors around the world recognise that this poses a
serious threat to the stability of our economies and the robustness of our financial
system.
Let me be clear from the outset: central banks and supervisors are not, and do not
intend to be, policymakers in the area of climate and nature. It is governments that are
responsible for climate and nature policies. In my remarks today, I will explain why
central banks and supervisors have no option but to take the ongoing climate and
nature crises into account to deliver on their monetary policy and banking supervision
mandates. And that is exactly what central banks and supervisors around the world are
doing. We at the European Central Bank (ECB) are not alone in this work, as can be
seen from the work being done by the Banco Central do Brasil and most other central
banks and supervisors around the world.
The relevance of climate and nature for central banks and supervisors
Human-induced global heating and nature degradation are scientifically established
facts. Their devastating consequences are becoming all the more apparent in the
increasing number of hazards we are seeing around the world. We don't yet know
exactly how the climate and nature crises will continue to unfold, partly because
governments are taking mitigation and adaptation measures. This uncertainty also
means that we don't know exactly how the economy and the financial system will be
affected.
At the same time, analysis consistently shows the vital importance of climate and nature
for central banks and supervisors.
First, whatever happens, the economic impact will be profound. If left unchecked, global
heating and nature degradation will contribute to increased macroeconomic volatility as
climate and nature events become more frequent and have a greater impact on the
economy. A successful transition to a green and sustainable economy, meanwhile, will
require vast investment flows that will alter the way our economies function.
Second, the economic benefits of a timely transition far outweigh the costs, especially
when considered against the alternative scenarios of doing nothing or doing too little too
late.1
Third, climate-related risks translate into financial risks. Early work by the Basel
Committee on Banking Supervision (BCBS) shows that climate events are a driver of
each traditional type of risk considered in the regulatory framework, from credit risk,
liquidity risk and market risk to reputational and operational risk, including legal risk.2
Floods, for example, could damage a company's production facility, which could affect
its ability to repay a loan, in turn leading to higher credit risk for the bank that provided
the loan. Or consider what might happen if your house is built in an area vulnerable to
wildfires. Your home could fall in value, leaving the bank that granted you the mortgage
with higher risk on its balance sheet.
And these financial risks are not related solely to climate change. Last year, when
looking at more than 4.2 million individual companies that account for over €4.2 trillion
in corporate loans, we found that nearly 75% of all bank loans in the euro area are to
3
companies that are highly dependent on at least one ecosystem service. Examples of
these services include the products we obtain from ecosystems, such as food, drinking
water, timber and minerals; protection against natural hazards; or carbon uptake and
storage by vegetation. If these ecosystem services continue to experience the level of
degradation they are currently facing, the stability of individual financial institutions and
the broader financial system will be at risk.
International standard-setting bodies driving global action
Recognising the relevance of climate and nature-related factors for the economy,
including the financial system, international standard-setting bodies are increasingly
turning their attention to this topic. This has resulted in substantial progress at the
global level, although more work lies ahead of us.
For example, the BCBS has a dedicated Task Force on Climate-related Financial Risks,
whose meeting this week is kindly hosted by the Banco Central do Brasil. Based on the
work of this task force, the BCBS has taken concrete steps to incorporate
climaterelated financial risks into the Basel framework for the global prudential regulation of
banks. And progress has been made across all three pillars of the prudential
framework: regulation, supervision and disclosures. On the topic of disclosures, late last
year the BCBS issued a consultation paper on a proposed climate-related disclosure
requirements framework, building on the work done in various other fora. The deadline
for comments was two weeks ago and we are now carefully assessing the feedback
received.
Meanwhile, there is also progress on nature-related risks. In view of the Brazilian G20
Presidency's priority to deepen work on sustainability-related risk, the Financial Stability
Board (FSB) will this year complement its climate-related work with a stocktake of
current and planned regulatory and supervisory initiatives regarding nature-related
financial risks. This may build on the work already done by the Central Banks and
Supervisors Network for Greening the Financial System (NGFS). Last year the NGFS -
which has 138 members worldwide, including the Banco Central do Brasil - published a
conceptual framework to guide action by central banks and supervisors in the area of
nature-related risks.
The work currently being done by the BCBS, the FSB and the NGFS will ultimately find
its way to other international standard-setting bodies and translate into concrete
practices by individual central banks and supervisors.
ECB measures to take climate and nature into account
Let me give you some examples of actions we have taken at the ECB.
In 2021 we unveiled an ambitious climate action plan covering macroeconomic
modelling, financial stability monitoring, data collection, risk assessment capabilities
and our monetary policy operations. Many of the actions we planned have now been
delivered. For instance, we have made significant progress in improving the models that
we use in macroeconomic analysis supporting our monetary policy decisions.
Moreover, we have in place a methodology to tilt the purchase of corporate bonds
towards issuers with a better climate performance - if we ever need to buy corporate
bonds again in the future. In the collateral framework for our lending operations, we only
accept assets that comply with the relevant sustainability reporting requirements and
we are looking at setting limits on the share of assets issued by entities with a large
carbon footprint.
In the area of banking supervision, we have urged banks to ensure the sound
management of climate and nature-related risks, using the supervisory expectations we
published in 2020 as a starting point. These expectations give guidance on how banks
should integrate climate and nature-related risks into their strategy, governance and risk
management. It is very much consistent with the general supervisory principles that
have been established by the BCBS.
Since the ECB first started discussing climate and nature-related risks with banks back
in 2019, progress has undoubtedly been made. Banks have taken steps to integrate
these risks into their strategy, governance and risk management. Although at present
none of the banks under our supervision fully meets all our expectations, each of our
expectations has already been fulfilled by at least one bank. It shows that progress is
possible, and that it is not just taking place among a few banks, but across the board.
This is good news, since we expect all banks under our supervision to be fully aligned
with our supervisory expectations by the end of 2024. We will enforce this final deadline
as well as several interim deadlines. In fact, a number of banks under our supervision
have already received binding requirements to remedy shortcomings by a certain date.
If they do not comply, they will have to pay a penalty for every day that the
shortcomings remain unresolved.
Building on the results achieved and progress made, earlier this year the ECB
announced a new climate and nature action plan. It sets out concrete steps to consider
how, within our mandate, we can further support the green transition, assess the
physical impacts of climate change and explore the materiality of nature-related risks.
Moreover, when we completed a review of our operational framework for implementing
monetary policy two weeks ago, we announced that climate change-related
considerations will be incorporated into the design of future structural monetary policy
operations.
Conclusion
Let me conclude.
The Amazon river is subject to the "Pororoca", one of the largest tidal bores in the
world. It is an enormous wave travelling from the mouth of the Amazon on the Atlantic
coast up to 800 kilometres upstream.
The climate and nature crises are unfolding. Together they are overflowing the
economy and the financial system, very much like the "Pororoca" overflows the Amazon
basin. Even if mitigation and adaptation measures are taken, one thing is certain: the
world, the global economy and the financial system will see profound change.
In the words of Brazilian author Paulo Coelho: "You drown not from plunging into the
water, but from staying submerged in it." Emerging from the climate and nature crises
requires action from all authorities within their mandate. For central banks and
supervisors, this means taking climate and nature into account in the pursuit of their
monetary policy and supervisory objectives. If they failed to do so, they would be failing
on their mandate. The work that we are doing individually and collectively proves that
we will not allow this to happen.
Thank you for your attention.
1
Emambakhsh, T. et al. (2023), "The Road to Paris: stress testing the transition
towards a net-zero economy ", Occasional Paper Series , No 328, ECB.
2
Basel Committee on Banking Supervision (2021), Climate-related risk drivers and
their transmission channels , April.
3
Boldrini, S. et al. (2023), "Living in a world of disappearing nature: physical risk and
the implications for financial stability ", Occasional Paper Series, No 333, ECB.