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Central banks need to be greener

Guest contribution published in "Die Zeit" on 07.12.2017

One of the goals of the Paris climate agreement of December 2015 is to make "finance flows consistent with [...] climate-resilient development". But how can the financial markets make a comprehensive contribution to achieving climate targets? Until now, the traditional “magic triangle” of financial investment has consisted only of return, risk, and liquidity.

Adding sustainability to the equation could turn this triangle into a square if market participants take the environmental and social sustainability of a particular investment into consideration as well. In this case, sustainable investment would not just be the environmental icing on the cake, but would become a core component of financial strategies.

The market for green coupon securities, for example, is still in its infancy; since 2007, a total of around €250 billion has entered the market. Growth, however, is enormous. Potential on the €2,600 billion global stock market is even greater, with demand vastly outstripping supply – markets for sustainable asset classes are often not sufficiently liquid to allow for large-volume investments.

Sustainable investment has tangible benefits – investors can plan for the long term and hold assets with promising futures. Studies show that sustainable forms of investment are capable of generating particularly high risk-adjusted returns. As a result, not only does this type of investment follow an ethical and moral imperative; it also serves the investor’s own economic interest.

The Bundesbank is neither willing nor able to prescribe sustainable investment. Within its strictly limited mandate, however, the Bank can and does support sustainable investment. Since 2007, we have pursued sustainable investment strategies when managing the public funds entrusted to us. In order to promote similar strategies elsewhere, the Bundesbank has established and chairs a federal states’ working group for sustainability indices. The group aims to develop effective, sustainable equity indices – and, in the future, possibly indices for bonds as well.

As a banking supervisor, the Bundesbank is also in a position to raise awareness of climate-related risks and ensure that financial institutions manage them appropriately. In this regard, for example, risks to the underlying value of financial assets must be taken into account. According to estimates, if the Paris accords were implemented, around 80 per cent of the fossil fuels on the balance sheets of large energy companies would remain unused and have to be written off.

Even today, credit institutions must be able to prove to supervisors that they have a firm grip on all material risks affecting their enterprises – including risks related to climate change, if applicable. As part of the reform of European supervisory authorities, legislators in Brussels are currently discussing whether banking supervisors’ legal mandate should stretch to assessing the sustainability of banking activities.

As a central bank with a mandate for financial stability, we also need to keep an eye on the financial sector as a whole. This presents two fundamental questions: can the financial system cope if substantial assets in entire parts of the country are devalued due to natural disasters or other consequences of climate change? Or if political action to limit climate change devalues certain investments that are fuelled largely by the use of carbon? While the first question is concerned more with climate-related risks, the second is very closely linked to the political response to climate change – and the uncertainty that comes with it.

To be able to answer these questions satisfactorily and assess the risks, we need comparable environmental data and must ensure that enterprises’ climate-related financial risks are made more transparent. There is a lack of effective rules at present, which is why one of the aims of the German G20 presidency was to make these data available.

By contrast, taking sustainability criteria into account in monetary policy is proving to be more difficult. Giving preferential treatment to sustainable financing instruments over others would be incompatible with the principle of competitive neutrality. Furthermore, the Bundesbank cannot jeopardise its mandate of maintaining price stability by pursuing other political goals.

Additional information

The Author

Member of the Executive Board - Prof. Joachim Wuermeling

Contribution by Joachim Wuermeling,
Member of the Executive Board of the Deutsche Bundesbank

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