How central banks could help fight against climate change

Our Chief Investment Officer takes an in-depth look at how central banks are helping to fight against climate change.
Bank of England
Reading time: 10 mins

The impact of climate change is already touching the lives of many of us. It can be clearly seen through its devastating impact in the form of hurricanes, storms, more volatile temperature ranges, and wildfires across the world. Without action, these events will only persist, and the long-term consequences are likely to become more extreme[1] and worse, potentially irreversible.

Thankfully we are seeing a shift towards a greener economy right now. This has been highlighted by the increased popularity of ethical investing and a rapid rise in government regulation in recent years. For a touch of optimism, it’s worth considering this chart highlighting the increase in sustainable finance policies around the world.

cumulative number of policy interventions

(Source: https://www.unpri.org/policy/regulation-database

While at an individual level our direct actions may feel minimal, the collective shift of millions of little changes could make a significant difference. So, it’s important for individuals to keep on recycling and trying to keep our carbon footprints down, however, it’s up to businesses to put in the effort too. One way this could be encouraged is by using environmental impact, in addition to corporate earnings, as a way of determining a company’s success. This subtle but important shift may see more businesses and organisations start to transition towards a greener economy, which could have a hugely positive impact on the world.

What are the economic consequences of climate change?

Although the environmental impact of climate change is often talked about, the effect on the economy isn’t commonly mentioned in mainstream news or conversations.

In fact, there are several areas where climate change is likely to impact the global economy:

  1. Change in productivity
  2. Destruction of assets
  3. Physical risks (and opportunities)
  4. Transition risk (and opportunities)

Let’s take a look at each of these in a bit more detail.

Change in productivity

As we see more dramatic weather changes – the recent wildfires in California and Greece, or floods in Germany or China for example – productivity is understandably likely to slow, especially in industries that require outdoor activity or ambient temperatures. In fact, we’re already beginning to see this. According to the International Labour Organisation, global labour productivity loss due to heat stress is expected to increase from 1.4 per cent in 1995 to 2.2 per cent by 2030 – provided we stay below the 1.5°C temperature goal set by the Paris Agreement.[2] To put that into context, that’s the equivalent of losing 80 million jobs due to climate change!

Destruction of assets

We’ve already mentioned wildfires and floods, and it’s likely that we’ll see the effects of climate change increasing the frequency and severity of these natural disasters. And although our first thoughts are with the loss of life and nature, a huge amount of property, materials, and other assets (such as vehicles, roads, and machinery) are often destroyed too. This impact hinders local businesses and economies, which could have a knock-on effect on wider economies depending on how far the damage spreads.[3] This isn’t a new phenomenon either, a decade ago Thailand experienced large amounts of flooding, which caused a significant impact on the global automotive supply chain due to the disruption in chip production.[4]

Transition risk (and opportunities)

Transition risks (and opportunities) are the changes that could happen across society during the shift towards a low-carbon economy. And there are many things that could drive these risks. For example, changes in public policies and regulations would have an influence on corporate liabilities. Additionally, risk or opportunity could arise from the wide scope for greater innovation and/or existing and new technologies becoming more affordable.

Part of these risks also factors in how investor and consumer sentiment changes towards a greener environment. Historically, economies have been impacted by, and so central banks have closely monitored, how this sentiment changes long-run behaviours. The scale and complexity of transition-related change could potentially have a greater impact than anything seen previously.

It’s also worth noting that most transition risks are global, however different countries and economies are likely to see variations in the specific nature of that risk. This also means that there are significant opportunities for those economies and businesses that successfully adapt.

Physical risk (and opportunities)

Physical risk refers to the changes that will come from both weather and climate that impact economies. These risks could be temporary, as a result of extreme weather events, or long-term due to gradual but persistent shifts in climate. While banks, insurers, and governments are aware of these risks, the frequency and severity of each risk are extremely difficult to predict.

In 2020 alone, global natural disasters caused losses of $210bn – significantly higher than the previous year which saw $166bn in losses. [5] However, the distribution isn’t evenly shared – the US saw natural disasters causing $95bn in losses, while in Asia these came to $67bn while Europe saw the lowest losses at $12bn. [5]

This uneven distribution of losses caused by natural disasters could hold risks for some economies while providing opportunities for others.  For example, a general increase in temperatures could see economies in more ambient temperatures pick up, while those which regularly experience natural disasters could struggle.

What part could central banks play in the fight against climate change?

In 2015, 196 parties adopted the Paris Agreement to limit global warming to below 2 degrees Celsius (or ideally 1.5⁰C). This is a legally binding treaty to reach global peaking of greenhouse gas emissions as soon as possible and achieve a climate-neutral world by 2050.

To achieve this, many climate goals are in place, giving countries something to aim towards when reducing their greenhouse emissions. These goals are set in 5-year cycles, with ambitious targets to reduce emissions, put long-term strategies in place, and build resilience against the impact of rising temperatures.

There are many ways that countries can achieve these goals, and the most effective ways tend to be through a combination of tax and incentives – also known as fiscal policy. Although fiscal policy is set by the government, the central bank could then adapt its monetary policy to use green incentives to change the cost of borrowing based on climate impact.

How central banks work with climate issues

Many central banks have written on climate change, but for global action it is important they are all coordinated. For this, an organisation called the Network for Greening the Financial System (NGFS) was founded back in 2017 and is currently made up of 95 members, primarily central banks but also many international financial institutions. This provides a forum to work together, exchange experiences, share best practices, contribute to the development of environment and climate risk management in the financial sector, and ultimately mobilize the power of mainstream finance to support the transition toward a sustainable economy.

The NGFS have developed climate scenarios with varying intensities of climate change and transition to look at how the likes of greenhouse gas taxes, prices, investment, food production, and financial variables may change over time. These scenarios could be helpful to assess whether there will be a periodical need to adjust monetary policy if, say, taxes or the demand for skilled labour in green industries push up inflation. They’re even stress testing to find out if any credit institutions or insurers are particularly vulnerable to climate change and the transition to a green economy. [6]

The importance of providing stability

Although we’ve talked before about how volatility can be good for investing (it causes the ups and downs that your money can benefit from), for a transition to a green economy to take place, we need some form of stability, in particular, policy stability.

Stability allows for better planning, which means that people, businesses, and governments can take a long-term approach to green investments. Thanks to the efforts of central banks and NGFS, we have more understanding of the impact of finances and climate change, as well as the risks associated with doing nothing. This knowledge could help drive stable policy and enable a transition to a green economy, one such example is the UK government’s initiative to provide tax incentives to encourage increased consumer appetite for electric vehicles.[7]

The future isn’t written

With the Intergovernmental Panel on Climate Change’s 2021 report, many of the conclusions were very bleak. But thinking negatively won’t help to change our current course and there are plenty of reasons to remain positive about the future. For instance, the first of the UN’s seventeen Sustainable Development Goals is to eliminate poverty, and since 1990 more than 1.2 billion people have risen out of extreme poverty.[8]

Also, many private companies around the world are already taking important steps to become carbon neutral – many with target dates of 2030 or 2045. Maintaining this positivity, tackling Climate Change is cited as the number one priority by European CEOs[9], but this must translate into action.

We’re seeing huge energy-saving projects already taking place, and in recent years, there have been lots of new exciting developments in green technology. This advancement has seen a huge influx in green loans and bonds[10] giving ethical investors more and more choice over what can be included in their portfolio. This rapid rate of innovation is likely to bring many opportunities for firms, including opportunities in sectors that don’t currently exist.[11]

If you build it, they will come

Although central banks are working hard to understand the risks so the world can move towards a greener economy, individuals, governments, and businesses will also have to adapt significantly for this transition to be a success.

The need for action cannot be understated, and there is plenty that you as an individual can do to make an impact. The key is finding a way to encourage a collective shift towards a greener future, whether that’s through voting for parties who are aligned with your beliefs on the environment, urging your employer to improve their green practices, or making your money count by putting it in organisations that are committed to protecting our planet.

Here are a few ways that you could help change the world and build a greener economy:

  • Pension – with an ethical pension you not only help to save for your future, but your money could also help to create a greener future for everyone.
  • Savings and current account – by being selective over the banks your money is with, you can avoid supporting activities that aren’t environmentally friendly and instead take a more active role in encouraging the transition to a green economy.
  • Ethical Investing – you don’t have to be rich to invest ethically. In fact, you could start investing with just £1 and you’ll be actively helping businesses and organisations that are trying to have a positive impact on the environment.

With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.

Each of these steps can have a positive impact without drastically changing your day-to-day lifestyle.

But if you think it sounds too complicated or time-consuming, then maybe Wealthify could help? Our team of experts are constantly monitoring our customers’ Ethical investments, ensuring that they maintain our ethical standards, and engaging with fund managers to encourage change within the underlying companies. For an idea of some of the companies we invest in, please see our Good Egg posts which discuss some of the positive impacts that ethical investing can have.

 

 

 

  1. https://yaleclimateconnections.org/2019/07/how-climate-change-is-making-hurricanes-more-dangerous/
  2. https://www.ilo.org/global/about-the-ilo/newsroom/news/WCMS_711917/lang--en/index.htm
  3. https://hbswk.hbs.edu/item/who-pays-for-wildfire-and-hurricane-damage-everyone
  4. https://www.reuters.com/article/us-thai-floods-idUSTRE79R0QR20111028
  5. https://www.munichre.com/en/company/media-relations/media-information-and-corporate-news/media-information/2021/2020-natural-disasters-balance.html
  6. https://www.loveelectric.cars/our-pledge
  7. https://www.bankofengland.co.uk/prudential-regulation/publication/2018/enhancing-banks-and-insurers-approaches-to-managing-the-financial-risks-from-climate-change
  8. https://www.worldvision.org/sponsorship-news-stories/global-poverty-facts
  9. https://www.bcg.com/en-gb/about-us/about-bcg/weekly-briefs#may24
  10. The annual issuance of green loans and bonds from non-government issuers has grown from 33 billion dollars in 2014 to 238 billion dollars in 2020, see Climate Bonds Initiative (2021).
  11. https://hbr.org/2021/07/the-green-economy-has-a-resource-scarcity-problem

 

 

With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.

 

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