Central banks must respond to climate change, says Bank of England

The question is not if but where, and to what extent, central banks should respond to the climate crisis, the Bank of England (BoE) said on Tuesday.

At a Reuters event about responsible business, the bank’s governor Andrew Bailey made a speech in which he said that although central banks are not here to “solve” climate change, they do have an important role to play.

Bailey said that the economy and financial system are “not immune” to planetary-level changes or society’s response to them and that climate change is in a sense “the ultimate system risk.”

Despite the existence of physical and transitional risks associated with climate change, he said, they are not reflected in the market prices of most financial assets.

“Structural barriers such as the lack of climate disclosure, the lack of clear sector-level climate policies, firms not internalising the cost of emissions, and the short time horizon of some investors, all contribute to what Nick Stern has described as the greatest market failure the world has ever seen,” he warned. “A sharp shift towards a new equilibrium as a result of recognising the full extent of this market failure could create significant financial losses in a ‘climate Minsky moment’.”

The governor suggested that central banks should be building resiliency at a micro and macro level by ensuring the financial system “proactively manages and pre-emptively mitigates the financial risks from climate change.”

He said that this task would fall squarely within the mandate of the Prudential Regulation Authority (PRA) and the Financial Policy Committee (FPC.)

The PRA has set supervisory expectations for banks and insurers to ensure they adopt a strategic approach to climate change and develop capabilities to effectively identify, measure, manage, and where outside appetite, mitigate the financial risks from climate change.

The FPC, alongside the PRC, will launch next week a Climate change Biennial Exploratory Scenario exercise – the CBES - to assess the resiliency of individual banks, insurers and the wider financial system to different climate scenarios.

Beyond the financial system, Bailey said that achieving economy-wide zero emissions will require “greening” the way buildings are heated, industrial goods are manufactured, food is produced, and electricity is generated.

Although he said that central banks must play a role in addressing climate change, the biggest component of the journey to net-zero “rests not with banks but with the government.”

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