The Bank of England has helped pioneer the fight against climate breakdown in the financial sector. Governor Mark Carney made a game changing speech in 2015, warning that climate change and the transition towards a green economy poses systemic risks to the financial system.

Now, in a letter to the Financial Times, 60 renowned academics are calling on the Bank of England to lead by example and integrate climate criteria into its monetary operations, namely its collateral frameworks and asset purchases.

A successful green transition means realigning finance and capital to a more ecologically sustainable footing. However, it also means deflating potentially the biggest asset price bubble in history: the carbon bubble. Indeed, the implications of climate change could potentially make the devastation of the last 2008 global financial crisis seem like a walk in the park.

Carbon intensive businesses risk huge losses because their activities and market value are still partly dependent on the assumption that what environmental campaigners call unburnable carbon’ will nonetheless still be extracted. These losses could reverberate through the financial sector, wiping out trillions of pounds worth of assets.

Leaving most of the world’s oil, gas and coal in the ground means assets in carbon intensive industries assets may be grossly overpriced, and the infrastructure built and carbon intensive industries dependent on these reserves may become useless (known as stranded assets’).

These losses could reverberate through the financial sector, wiping out trillions of pounds worth of assets.

With this in mind, the Bank of England has taken a number of commendable steps to ensure that our financial system is properly pricing in these risks and accounting for them in their day-to-day operations. But academics are now questioning whether the Bank is heeding its own advice. 

The letter warns that the Bank may be overreliant on private sector credit rating agencies for many of its monetary operations. These are the same credit rating agencies that gave investment-grade, money safe’ ratings to various sub-prime loans in the run-up to the 2008 global financial crisis.

While these private sector credit rating agencies have begun acknowledging the financial risks of climate change, they are yet to adequately price in the financial risks of climate change and the potential carbon bubble.

By failing to integrate climate-related financial risks into its operations, the Bank – and the taxpayer – is left exposed to these risks. But also, by underestimating the risks related to climate change, the Bank biases the allocation of capital and finance towards carbon-intensive activities – contributing to a carbon lock-in, exacerbating our unsustainable dependency on fossil fuels.

As the work of NEF and others have shown, the Bank’s current monetary operations are implicitly subsidising the sectors and activities that are most damaging to our planet.

The Financial Times letter explains:

The Bank’s collateral framework and asset purchases are extremely powerful and reverberate throughout the rest of the financial sector – affecting financial market prices and capital allocation more widely. When the Bank purchases assets or accepts them as collateral, their yields (borrowing costs) are lowered compared to other comparable ineligible assets.

This means that the current structure of asset purchase programmes and collateral frameworks create better financing conditions — an implicit subsidy — for fossil fuel sectors and the corporates dependent on them.”

The academics are calling on the Bank of England to decarbonise its operations, and effectively stop subsidising carbon intensive activities. This will not only leave the Bank less exposed to the financial risks of climate change, but will also help catalyse a sustainable green transition. 

As former central banker Pierre Monnin of the Council on Economic Policies states:

Such adjustments would realign central banks’ policies with the strong risk Standards needed for sound monetary policy. They would also generate financial incentives aligned with the transition to a low-carbon economy and send a strong signal to market participants to reflect climate risks in their decisions.”

Accordingly, the academics end their letter by stating:

The Bank of England needs to continue its commendable work as a global pioneer in this field — not just as a thought leader, but through the action it takes.”