Dombret: Green investment should not be given preferential regulatory treatment
Bundesbank Executive Board member Andreas Dombret has come out against possible special rules in banking regulation designed to promote "green investment". In his opinion, it does not make sense to tip the regulatory scales against environmentally unfriendly "brown" investments or in favour of "green" financial assets on bank balance sheets, such as by reducing capital requirements. Speaking before banking industry representatives at the Bundesbank symposium "Banking supervision in dialogue" in Frankfurt am Main, he said that
"sustainability in the sense of environmental friendliness does not necessarily go hand in hand with reduced risk".
Valdis Dombrovskis, Vice-President of the European Commission, presented proposals to promote green investment in December 2017. The initiative was designed to support the European Union’s objective of reducing greenhouse gas emissions by 40 per cent between 1990 and 2030. The European Commission recently published an action plan on this matter.
Dombret’s take on this is that promoting the greening process should not take place through the back door via financial market regulation and banking supervision. Capital requirements, in his view, should be calculated on the basis of just a single factor – the riskiness of the exposures in question. According to Dombret, proposals for special rules are dangerous.
He believes financial market regulation and banking supervision need to be focused on their core tasks and geared to risk.
"Watering down the regulatory mandate would create conflicts of interest and ultimately lead to risks to financial stability – and surely that cannot be what we want." Instead, he thinks it is worth considering the use of other, traditional instruments, such as tax incentives, to foster the development of green economic sectors.
"This approach is more effective and limits unwanted side effects for financial stability", he noted, adding, however, that tax disincentives for "brown" investments were also conceivable.
Potentially disruptive technological advance
The Bundesbank Executive Board member remarked that far-reaching changes to the existing economic systems were necessary if the global community was committed to hitting the ambitions target of 2 degrees Celsius, emphasising that the entire way in which business was done and the path along which the economy and society were progressing needed to be transformed. He pointed out the risks to banks and savings banks raised by, for instance, natural catastrophes if the assets these institutions finance, such as real estate, production facilities or tradables, were affected. Transition risks along the path to a green economy should not be underestimated, either: to make this transition, potentially disruptive technological advances and far-reaching changes in climate policy were called for, Dombret said. He added that it was safe to say that this upheaval would require market participants to set new prices for many assets.
German banks and savings banks were directly affected thanks to their lending practices, with around 60 credit institutions extending more than 10 per cent of their loans of €1 million or more to energy suppliers, coal mining groups or firms involved in the extraction of crude oil and natural gas as well as in the processing of coal and mineral oils. Dombret believed that the severity of the impact was virtually impossible to assess, as there was still great uncertainty about the exact shape of the greening process. It was therefore not enough to examine the issue of greener finance through the lens of corporate social responsibility, Dombret said, adding that "potential climate-related risks need to be taken into account as part of risk management".
However, he pointed out that the transition to a greener economy would also create considerable opportunities; the economic transition, he believes, will also open up new business areas for banks and savings banks. In this context, he cited estimates according to which the level of global investment needed to achieve the climate goals could run into the tens of trillions. The European Commission anticipates that annual investment of €180 billion will be needed in the European Economic Area just to achieve the Paris climate targets by 2030. Also, retail demand for green investments has increased significantly in recent years. Credit institutions need to gain expertise at an early stage in order not to fall victim to typical investment risks.
Dombret firmly believes that supervisors and central banks themselves should strive to perform a special role as a role model and catalyst.
"This means, for example, helping to forge a deeper understanding of how the mechanisms behind the risks work," he noted, referring to the Central Banks and Supervisors Network for Greening the Financial System (NGFS).
"Capital requirements should remain risk-based"
Klaas Knot, president of the Dutch central bank, shares Dombret’s scepticism of possible lower capital requirements for green investments.
"Capital requirements should remain risk based," Knot said at the symposium. Green investments could be boosted in the short term by easing capital requirements, but the risks would also increase. "Brown" investments were currently too attractive because their actual risks were not priced into the investments. A decisive factor in banks’ goals, according to Knot, was clear and long-term transition legislation. However, for many parts of the economy, no such regime was in place just yet, hampering banks’ ability to steer their business activity towards certain sustainability goals. Knot therefore believes that it is advisable to use scenario analysis and stress testing as tools in order to assess the potential losses in certain business areas caused by legislation or technological change. At all events, sustainability factors and climate issues warrant the consideration of banks and supervisors since they can affect the solidity of financial institutions.
At a panel discussion, Eberhard Brandes of WWF Germany said that the banking industry was not playing a leading role in the debate on sustainability. He noted a certain restraint on the issue. On the other hand, Richard Böger of the Bank für Kirche und Caritas explained that the entire asset side of his institution’s balance sheet was screened for sustainability.
"Yield is not everything; this naturally goes beyond the mind-set of traditional bankers," he said. Johannes-Jörg Riegler of the Bayerische Landesbank cautioned that young, would-be employees were specifically scouring potential employers for sustainability considerations. This was an area in which firms had an opportunity to stand out from the crowd. Günther Bräunig, CEO of KfW, explained that sustainability was at the top of his organisation’s agenda, saying that
"it is now time for us to deliver."