Covid, central banks and climate change

Three priorities for sustainable crisis response strategies

One of the more surprising outcomes of the Covid-19 crisis is the way it has deepened efforts across the financial system to confront climate change and build a sustainable economy. In volatile markets, funds that incorporate environmental, social and governance factors have generally outperformed their conventional rivals. More and more central banks have committed to green finance, recognising the shared roots of the pandemic and climate change in intensifying environmental degradation.

In the first wave of central bank action to confront the economic shock, however, few if any authorities directly incorporated climate or other ESG factors into their crisis response measures.

Out of 170 central banking and supervisory actions that were taken up to the end of May, only five explicitly included sustainability considerations. Liquidity-enhancing measures that are not aligned with sustainability objectives could contribute to the build-up of climate-related risks, locking in business models that are exposed to the accelerating shift to a zero-carbon economy.

In June, the International Network for Sustainable Financial Policy Insights, Research and Exchange released a toolbox of sustainable crisis response measures. Produced by the London School of Economics and Political Science and the School of Oriental and African Studies, the toolbox set out how a range of monetary, prudential and other instruments could be calibrated to avoid accentuating climate-related financial risks.

To develop truly sustainable crisis response strategies, three priorities stand out. The first is for central banks to adjust the risk assessment underlying their collateral frameworks to take better account of climate-related risks.

The second is for central banks to align their asset purchase programmes and refinancing facilities with the Paris climate agreement. The third is to give climate-related risks greater emphasis in prudential regimes in the current easing of countercyclical instruments.

The need to join the dots between Covid, central banks and climate change is clear, not least as leading governments, businesses and investors focus on delivering a green recovery. Positive examples are emerging of practical actions to make this happen. In September, the European Central Bank decided to accept sustainability-linked bonds as collateral and for Eurosystem monetary policy purposes.

This type of action needs to become the norm.

Nick Robins is Professor of Sustainable Finance at the London School of Economics and Political Science. This article originally appeared in the Sustainable Policy Institute Journal.

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