could enable or hinder the transition, with implications on asset price volatility and financial stability (Battiston et al. 2021).

_4. Foster climate policy coherence and credibility,_ which plays a key role in the investors’ climate sentiments (see condition 3). In the context of the low-carbon transition, policy coherence is still low both in low-and high-income countries. In the latter, fossil fuels subsidies and renewable energy subsidies often coexist. Overall, climate policy introduction (e.g., a carbon tax) is still delayed. Contradictory signals prevent investors to adapt their business for the low-carbon transition, failing to internalize the costs and co-benefits of climate policies in their risk assessment and management. As highlighted by the NGFS “ _Operationalizing climate neutrality in the context of policy coherence is critically important to ensure that the actions of central banks are not perpetuating a high-carbon status quo in financial markets that delays a transition in the real economy_ ”. The question of policy coherence is particularly relevant for monetary policy because of the significant size of central banks’ balance sheets and the increased impact on the economy and financial markets. Here it will be vital to ensure that a climate-neutral calibration of instruments does not impair central banks’ ability to exercise their primary functions and to avoid potential conflicts associated with a ‘supportive role’ of central banks (NGFS 2021).

_5. Accounting for the interdependence across financial institutions and financial markets_ . In the aftermath of the 2008 financial crisis, many financial supervisors recognized the failure of traditional stress-testing for banks (Haldane 2009) and the importance of modeling the financial system as a network (Bardoscia et al. 2021). This view is widely recognized today and reflected in the policy actions and discourse of financial authorities globally (see e.g., Yellen (2013) for a US and Noland and Park (2015) for an Asian perspective). Indeed, network effects of various kinds had a key role in the 2007–2008 financial crisis, the impact of which persists after more than a decade. For instance, according to the Bank for International Settlements (BIS), the largest part of losses suffered by financial institutions during the financial crisis was not due to actual counterparties’ defaults, but to the mark-to-market reevaluation of obligations following the deterioration of counterparties’ creditworthiness.<sup>33</sup> In other words, they were due to _network effects_ . In addition, in the aftermath of 2008, it has become widely accepted that micro-prudential regulations can have undesirable macro-level repercussions, due to network effects and procyclical effects (Adrian and Shin 2010) and that macro-prudential regulation should be pursued instead (Borio et al. 2014). In the context of the low-carbon transition, recent balance-sheet climate stress test have analyzed how financial interconnectedness can lead to a reverberation of losses across financial institutions with implications for systemic risk (Battiston et al. 2017). This holds in particular, if financial actors fail to adequately embed climate scenarios in their

> 33 The Basel Committee on Banking Supervision states that “roughly two-thirds of losses attributed to counterparty credit risk were due to Credit Valuation Adjustment (CVA) losses and only about one-third were due to actual defaults”; see BCBS (2011).

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