The Role of Banking and Monetary Policy in Financing a Green Transition

1. The Role of Banking and
Monetary Policy in Financing a
Green Transition
New Economics Foundation
29th June 2017th

2. 1. The missing role of central and commercial
banks in promoting green investment.
2. The credit creating powers of central banks and
commercial banks.
3. Specific instruments central banks can use to
stimulate green investment.
4. Some case study evidence & policy lessons.
Introduction

3. 1) Externalities
2) Lack of R&D
3) Short-termism in capital markets
4) Poor networks
5) Information
6) Not recognising co-benefits
Climate change
is the
“greatest market failure”

4. 1) Externalities
2) Lack of R&D
3) Short-termism in capital markets
4) Poor networks
5) Information
6) Not recognising co-benefits
Climate change
is the
“greatest market failure”
What about banks?
What about central banks?

5. The mainstream ‘Real’
Economy
Production/ Firms Households/
Consumption
Purchases of goods &
services
Wages & Salaries
Government
Taxation
Public spending

6. What do banks do?
Savings = Investment

7. The ‘real’ economy with
banks
Production/ Firms Households/
Consumption
Purchases of goods &
services
Wages & Salaries
Government
Taxation
Public spending
BANKS
INV  SAV

8. The ‘real’ economy with
banks
Production/ Firms Households/
Consumption
Purchases of goods &
services
Wages & Salaries
Government
Taxation
Public spending
BANKS
INV  SAV

9. Really
Show me the Proof?

10. “Commercial [i.e. high street] banks create money, in
the form of bank deposits, by making new loans.”
Banks create credit

11. Money creation in the UK:
dominated by commercial banks,
not the state
Note: Money created by banks relates to quarterly amounts outstanding of UK resident monetary financial institutions' sterling M4
liabilities to the private sector excluding intermediate OFCs (i.e., other financial corporations), seasonally adjusted.

12. Hierarchy of money
Central bank/
state money
(CB reserves & cash)
Commercial bank money
Business IOUs (trade
credit)
Personal IOUs
Most
acceptable
Least
acceptable

13. Intra-day clearing &
overnight settlement

14. Central Banks
• Central banks create money to provide
the final means of settlement
• Act as ‘lender of last resort’ to banking
system
• Typically focused on two main
objectives:
– Price stability (inflation target)
– Financial stability (liquidity & solvency of
banking & payment systems)
14

15. Central Banks
• Central banks are key macroeconomic actors: set
interest rates, create credit (liquidity), and regulate
banks
• Since 1980s focus narrowed to price stability
• Financial crisis has led to fundamental rethink &
‘unorthodox’ policies as interest rates reached zero-
lower bound in many OECD countries
• New questions about central bank mandates and powers
– in particular as governments cut back on spending
15

16. Changing Role of
Central Banks
16
The recent large scale asset purchase
programmes of the world’s major central
banks raises questions about their role…

17. Climate can affect price and financial stability:
1) Physical (property or trade)
2) Liability (loss and damage)
3) Transition (repricing assets)
Changing Role of
Central Banks

18. Changing Role of Central
Banks
Near-term transition risk is the most urgent for
financial stability as could have big and rapid
consequences.
“Cannot consistently believe both of (i) reserves
are sensibly priced and ii) the world will deliver
on the commitment to stay below 2 degrees…
Major risk that markets are grossly mispriced.”

19. Three policy
instruments
1) Macroprudential regulation
2) Influencing green credit creation
3) Green Quantitative Easing

20. 1) Macroprudential regulation
Macroprudential supervision ought to take into
account externalities that may give rise to
financial instability and identify the ecological
imbalances that may cause material financial
risks.
Includes: private sector disclosure, stress-
testing, capital buffers…

21. 1) Macroprudential regulation
(China)
MPA: The PBOC will add banks' qualified green
credit into collateral for monetary policy
operations and include institutions' green credit
performance in the central bank's macro-
prudential assessment (MPA).

22. 1) Macroprudential regulation
(Bangladesh)
Capital Requirements: Bank Bangladesh has put
first macro-prudential policy instrument, such
as lower equity margin requirements for
environmentally friendly projects, into place in
order to incentivise green initiatives.

23. 2) Green Credit Guidance
Credit allocation or guidance policies:
Historically played an important role in
developing and emerging economies, especially
in the 1950s, 60s and 70s, and still remain in
many emerging economies…
Includes: Targeted refinancing, reserve
requirements, credit quotas…

24. 2) Green Credit Guidance
(India)
The RBI has been implementing minimum
credit quotas in the form of Priority Sector
Lending requirements, to which it added in
requirements for commercial banks to lend
a portion of the 40% loan portfolio quota to
small renewable energy projects.

25. 2) Green Credit Guidance
(Bangladesh)
Launched in 2009, the central bank
established a US$ 25.5 million refinancing
window to promote green finance under
which the Bank Bangladesh offers to refund
commercial banks at a reduced interest rate.
The scheme was extended in February 2015
with by about US$ 250 million.

26. 2) Green Credit Guidance
(Lebanon)
The Banque du Liban supports green credits
by lowering the reserve requirements of
commercial banks by an amount of 100-
150% of the loan value if the bank’s
customer can provide a certificate from the
Lebanese Centre for Energy Conservation
(LCEC) that confirms the energy savings
potential of the financed project.

27. 3) Green Quantitative Easing
Where the central bank creates credit
directly financing/funding green enterprises
and infrastructure projects.
Or the central bank creates credit for public
intermediary to finance or fund green
enterprises and infrastructure projects.

28. 3) Green Quantitative Easing
Alice Amsden (2001) and Gerald Epstein (2005)
show that the central banks of many of the Asian
Tigers used a form of monetary financing to directly
fund their development banks.
Joshua Ryan Collins (2015) showed that from 1935-
1975 the Bank of Canada fully financed its Industrial
Development without triggering a balance of
payments crisis, let alone undesirable levels of
inflation.

29. 3) Green Quantitative Easing
Hines and Murphy (2015) note, that the
European Investment Bank already invests 10%
of its funding in developing countries. The ECB
could allocate a small portion of QE to
buy specially issued bonds (designed to fund
climate change projects) from the EIB.

30. 3) Green Quantitative Easing
Alternatively, central banks in the major
economies could cooperate and work with
the IMF, World Bank, the BIS and
governments to form a special QE
programme, specifically designed to raise
funds for the climate change initiatives.

31. 3) Green Quantitative Easing
Constraints: The extent to which less advanced
economies can implement their own type of
QE programmes to fund is limited – due to
limited reserve currency positions and less
liquid/developed capital markets. However,
many developing countries have managed to
get round this issue when using the money
creating powers of their central bank in a
responsible, targeted fashion.

32. Limits to central banks
• Risk of conflicting objectives
• Too much power to central banks
• Inflation and reserve currency constraints
• Jeopardising central bank independence
• Not a silver bullet – private sector
investment and fiscal policy necessary

33. Conclusion
• The role of Central Banks and monetary
policy in promoting green transition is
unexplored in mainstream debates.
• There are a number of policy instruments
available to central banks – when used
responsibly can help promote green transition.
• Task ahead is complex, successful transitions towards
Greener Economies will require substantial
cooperation b/w fiscal and monetary policy
*Citations available upon request.