MAY 2021 - Climate Bonds Initiative
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MAY 2021
Summary
While countries implement measures to reduce and recover from the economic impacts of COVID-19, they
also need to address the existential threat posed by climate change. These two problems both need
international coordination to manage the risks to human wellbeing and the financial system. There have
been calls for public bodies to tackle these problems together through ‘build back better’ and ‘Just
Transition’ strategies. Central banks are playing an important role on these agendas.
During the pandemic, central banks have provided liquidity to the financial system, supported fiscal
stimulus through purchasing government debt and directly stimulated real-economy activity through the
targeted provision of credit. Such uses of the central banks’ toolkits that have protected businesses and
stimulated recovery could be adapted to protect ASEAN member states from future systemic risks –
particularly climate-related risks.
This report highlights the range of prudential and monetary tools that support their mandates and reduce
environmental risks to the financial system. This report synthesises best practice on the ‘greening’ of
prudential and monetary policies and contextualises these into lessons that can be drawn on by ASEAN
central banks as they rebuild from the economic impacts of COVID-19.
The most critical step that ASEAN central banks can take is to establish clear roadmaps outlining
expectations for the greening of the financial system. A core element of these roadmaps, and one
recognized by the ASEAN central banks in their November 2020 report, is generating decision-useful
information on FI’s environmental-risk exposure so bank management, regulators and other stakeholders
can better understand and manage such risks.
Central banks have adjusted their policy toolkits to reduce to react to the pandemic. ASEAN central banks
could look at how similar adjustments could reduce exposure to climate-related risks. Some of the changes
to prudential regulation include:
• Stress tests: COVID-19 forced many central banks to delay or adjust microprudential stress testing to
limit the immediate resource and regulatory burden on FIs and banks. However, it is important for
central banks to resume environmental stress testing, to build capacity and understanding within FIs.
France’s ACPR recently published results for stress tests undertaken with volunteer banks and insurers
incorporating NGFS climate scenarios.
• Many central banks have loosened microprudential and macroprudential regulation in response to the
pandemic. Such changes can quickly increase the supply of credit to distressed sectors, for example
through releasing reserves from the countercyclical capital buffer. This can however inadvertently
provide credit for potentially environmentally damaging activities which contribute to future climate
risks. This could be lessened by excluding sectors with high transition risks from tapping this released
credit.
ASEAN Central Banks could also consider calibrating their monetary policy instruments, accounting for the
climate-related risks of different bank assets.
• Indiscriminate application of indirect monetary policy tools such as open market operations and standing
facilities can potentially lead to a build-up of carbon intensive assets, further increasing FIs’ exposures to
transition risks on their balance sheets. Changes to collateral frameworks could tilt lending activities and
adjust risk exposures.
• Similarly, direct monetary policy instruments to stimulate economic recovery could be greened. For
instance, corporate financing facilities, where the CB buys equity or bonds directly from issuers, could
also be tilted to encourage green investment.
2
Embedding sustainability into the COVID recovery - Climate Bonds Initiative
Contents
Executive Summary........................................................................................................... 2
Introduction...................................................................................................................... 4
The Economic Impacts of COVID-19 ................................................................................... 5
COVID-19: a preview of climate change’s impacts ............................................................. 6
Physical Risk ............................................................................................................................. 6
Transition Risk .......................................................................................................................... 7
How Central Banks Can Build Back Better .......................................................................... 9
Prudential Policy during COVID-19........................................................................................... 10
Microprudential Regulation .......................................................................................................................... 10
Macroprudential Regulation ......................................................................................................................... 11
Stress Testing ................................................................................................................................................ 12
Monetary Policy during COVID-19 ........................................................................................... 12
Indirect Monetary Policy Instruments .......................................................................................................... 12
Direct Monetary Policy Instruments ............................................................................................................. 14
Non-Standard Instruments ........................................................................................................................... 14
Conclusion ...................................................................................................................... 16
Short-term ..................................................................................................................................................... 17
Medium-term ................................................................................................................................................ 17
Endnotes ........................................................................................................................ 18
About this publication ..................................................................................................... 21
3
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeIntroduction
In 2020, COVID-19 devastated regards to the role of central banks stressed businesses continue to access
economies around the world. (CBs), this means first and foremost bank credit.
Governments were forced to take ensuring financial stability by limiting the
2020’s average global temperature was
immediate and unprecedented steps to potential negative impacts of future
the joint highest recorded in modern
save lives and livelihoods. As the health climate-related events (encompassing
times (tied with 2016).2 Climate change
crisis begins to stabilise and life-saving both the physical and transition risks
has remained high on global agendas
vaccines programmes are rolled out, from climate change). As CBs develop
with several countries setting net-zero
governments and central banks can now sustainability strategies and frameworks
targets. Positive developments have
look forward to ‘building back better’, (such as the Bangko Sentral ng Pilipinas’s
included the Network for Greening the
selectively boosting economic growth to Sustainable Finance Framework and the
Financial System’s (NGFS) continued
increase resilience and ensure stability. Monetary Authority of Singapore’s
efforts to publish a range of supervisory
There are growing calls for the public Green Finance Action Plan), the COVID-
guidance, as well as detailed climate risk
sector to provide society with transition 19 recovery presents an opportunity for
scenarios to aid climate risk-based stress
pathways that bolster economic and central banks to begin their
testing.
social resilience against the many implementation in both monetary and
challenges we face in the 21st century, prudential policy. There are opportunities for synergies in
chief among which is climate change. responding to the two threats. However,
A growing body of research is revealing
there are situations where there could
This policy brief aims to synthesise how climate change can affect financial
be conflicts between the two ambitions,
international central bank experiences in stability. As shown recently, AMS face
for instance, if emergency or stimulus
response to the economic recession considerable macro-financial risks
funding is provided in an untargeted
resulting from COVID-19 and identify stemming from the physical and
fashion. This could be mitigated by
opportunities to embed environmental transition impacts of climate change,
better targeting of emergency funding.
sustainability into stimulus and recovery risks that should be addressed by
Strategic interventions to ‘build back
efforts. Our objective is to provide monetary and financial authorities.1 As
better’ when making large-scale stimulus
suggestions on how central banking ASEAN Central Banks seek to stimulate
and recovery measures could maximise
tools can tackle and be informed by the recovery efforts from the economic
their longevity and ensure they do not
financial stability risks associated with recession caused by the COVID-19
increase portfolio exposure to climate-
climate change. pandemic, they may, anticipating the
related risks. Additionally, innovative
risks that climate change presents to the
ASEAN Central Banks have responded policies developed in response to the
financial system, also incorporate
quickly to manage the economic fallout pandemic could be reworked for climate
sustainability considerations. Central
of COVID-19, utilising their experience of risk management.
banks have an opportunity to consider
the Asian Financial Crisis and the Global
how their recovery programmes will: This paper is arranged as follows. The
Financial Crisis (GFC) to help their
first section synthesises how COVID-19
economies withstand the economic a) impede or improve national and
impacts the responsibilities of central
impacts of the pandemic. Banks had international climate change
banks. The following section summarises
built up capital and liquidity buffers, mitigation and adaptation efforts,
how COVID-19 relates to sustainability,
improved risk management practices and
outlining the impacts of climate change
and internalised the social cost of risk- b) incorporate transitional and physical
on financial stability. The paper then
taking, allowing them to weather the climate risk exposures into their
explores the tools available to central
COVID-19 financial crisis better than recovery programmes.
banks, examining those used in the
those crises which came before them.
Central banks have played a major role pandemic response and how these
While this paper commends the in the wider public sector’s effort to might be used to foster a sustainable
effectiveness of these responses, it combat the economic fallout from the recovery. This section also considers
notes that while ASEAN Member States pandemic since March 2020. Their focus whether any of the innovations recently
(AMS) have avoided and recovered more has been to ensure financial stability used by central banks could be applied
quickly from the severe domestic despite (temporary) double-digit falls in to climate risks. The conclusion draws
impacts experienced in many other economic activity and to finance upon this analysis to give suggestions for
countries, they are still vulnerable to the governments’ expenditure programmes. short- and medium-term action that can
global ramifications of lockdowns and The economic disruption from COVID-19 be taken by ASEAN Central Banks to
border closures. ASEAN nations also has led to unprecedented innovation in ‘build back better’.
have the opportunity to ‘build back how central banks use their policy
better’ ahead of other countries. With toolkits to supply liquidity and ensure
4
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeThe Economic Impacts of COVID-19
Though ASEAN countries have During this challenging time, ASEAN better’. Indeed, in the November
experienced lower per capita mortality Central Banks have focused on growth meeting of ASEAN Central Bank
rates than most other regions (except rates and inflation rates. Overall, the governors, they affirmed their support
North-East Asia), the region has still ASEAN GDP is forecast to contract by for a report on the roles central banks
experienced a heavy economic toll as a 4.4% (a downgrade from the 3.8% fall could play in managing climate and
result of containment measures, which made in the September update) due to environment-related risks.7
disproportionately impact countries the containment measures in 2020.4
Past crisis recovery can also provide
reliant on sectors like tourism (Thailand), Growth is expected to rebound to 6.8%
examples of how to rebuild from the
and as a result of high rates of COVID-19 in 2021, but prospects diverge within
COVID-19 crisis the response has already
in Europe and North America, which the region.5
utilised measures introduced during the
indirectly dampened exports from those
As they retrench in response to 2008 global financial crisis (GFC). Both
countries reliant on these trading
increased global risk, the speed and crises provide precedents for policy
partners (Viet Nam, Philippines).
scale of capital outflows by foreign changes and provide evidence on
In a joint meeting of ASEAN finance financial institutions (FIs) have revealed specific policies' strength in aiding both
ministers and central banks’ governors, ASEAN countries’ vulnerability to recovery and future resilience. The
attendees agreed to conclude that it was changes in market sentiments.6 This changes to policy and strategy following
imperative to “implement extraordinary economic contraction has exposed the both the Asian Financial Crisis and the
measures through targeted fiscal, vulnerability of economic systems to GFC show the opportunity for change
monetary and credit support to our real large external shocks and the presented by the current crisis.
economy and financial systems, as well importance of resilience to the
as reaffirming our commitment to the breakdown of international flows, hence
continued flow of goods and services.”3 the widespread calls to ‘build back
5
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeCOVID-19: a preview of climate change’s impacts
COVID-19 is not an isolated pandemic. global warming will create or amplify hence the roles and mandates of central
The virus has its roots in pathogens various risk types that can impact a banks.8 Such insight helps to frame what
jumping between species in degraded country’s financial and economic central banks need to consider and why
ecosystems and socioeconomic activities stability. they need to act. Applying such
that are ill-equipped to protect lives and knowledge to the tools used by central
This section seeks to reflect on the
livelihoods from environmental shocks. banks to maintain financial stability will
transmission mechanisms through which
Likewise, climate change will be a key elucidate how they can apply these tools
climate change can impact national
driver of environmental stress and effectively to mitigate the financial risks
economic and financial stability, and
degradation. There is clear evidence that posed by climate change.
Figure 1: Possible transmission of climate-related risks to financial
system vulnerabilities.
Source: Adapted from Board of Governors of the Federal Reserve System (2020) Financial Stability Report9
There is growing evidence that climate advances in renewable energy term climatic changes also present
change can present a risk to the financial supplanting fossil fuels, or chronic chronic physical risks; sea-level rise,
system through various forms. Figure 1 climate impacts such as sea-level rise. temperature increase, desertification
outlines these climate-related risks and and monsoon changes.
identifies the types of vulnerabilities
The ASEAN region is one of the most
within the financial sector that may be
exposed to different manifestations of
Physical Risk climate-vulnerable regions globally,
with.11
these risks. Climate change results in physical risks.
There has been an increase in the Climate-related disaster losses have a
Both physical climate change and
severity and frequency of acute hazards fiscal impact through damage to public
transition risks have profound potential
such as flooding, droughts and storm sector infrastructure (including
macroeconomic consequences. Some of
surges. These can affect corporations or buildings), crisis response spending and
these transmission mechanisms are
countries directly or indirectly via tax losses. Average annual losses as a
slow-acting and arise over multi-year
impacts on value and supply chains percentage of GDP have been estimated
time horizons.10 These include shifts in
caused by extreme weather. Longer- at 8.7% for Lao PDR, 8.0% for Cambodia,
consumer demand, technological
6
Embedding sustainability into the COVID recovery - Climate Bonds Initiative6.7% for the Philippines, and 6.2% for Mendelsohn (2005), the annual cost of electricity generation or commercial
Viet Nam. Singapore and Brunei, on the protecting Singapore’s coast is property in flood-prone areas). Similarly,
other hand, have not been so severely estimated to range from USD0.3-5.7 technological advances driven by efforts
impacted.12 Whilst exposure across the million in 2050 to USD0.9-16.8 million by to improve energy efficiency or
region differs between countries, the 2100.16 However, Singapore is an greenhouse gas emissions intensity of
interconnectedness of ASEAN markets advanced economy with a relatively existing economic processes can render
results in a high contagion risk of short coastline of only 193 kilometres. some technologies and business models
financial impacts. Such transmission was Countries such as Myanmar (with about obsolete. Transition risk will be felt
seen during the Asian Financial Crisis and 2,300km of coastline) and the heterogeneously across economies,
strongly implies the need to coordinate Philippines (36,289km of coastline) are depending both on businesses’ level of
action. The dangers of not taking action significantly more exposed and have sustainability alignment and their
are substantial. ADB calculates that communities more dependent on the adaptive capacity. Given the constraints
South-East Asia’s GDP will be 11% lower physical integrity and functioning of on their business models, there is a need
by 2100 under a business-as-usual coastal natural capital. There is also to increase SMEs' adaptive capacity to
emissions scenario13. close interaction between chronic and reduce their exposure to transition risks.
acute risks; sea-level rise further This is particularly vital in ASEAN, where
Many acute climate hazards will be
increases vulnerability to cyclones, and SMEs contribute 66% of employment
abrupt and physically catastrophic,
frequent extreme weather events will and 42% of GVA but have limited
posing a direct risk to human life,
reduce countries’ ability to adapt to long resources to invest in climate mitigation
causing physical damage and disruption
term climatic changes. and adaptation or obtain specialist
to businesses and economies. Extreme
advice to help them develop appropriate
weather can also have significant Overall, physical climate risks can
risk management strategies.19
impacts on sectors and households endanger the financial system through
physically damaged or interrupted by several mechanisms. Countering these It is often assumed that transition risks
bad weather. requires central banks to facilitate from climate policy unfold gradually as
investments (through regulation, credit governments introduce them in a
The Dutch central bank (DNB) undertook
enhancement and technical assistance phased and consultative manner.
climate physical risk stress tests
etc.)17 to improve resilience to climate However, external agents can revise
subjecting bank balance sheets to severe
change, governments to develop their policies quickly, materially
floods events likely to occur once in 200
climate-smart agriculture practices to impacting upon ASEAN countries. For
and 1000 years, in line with norms for
reduce economies’ vulnerability, and example, critical investors into ASEAN
shocks in financial supervisory
local banks to evaluate their investments economies, including Japanese20 and
frameworks. These lead to losses of
to understand and manage mitigation Korean banks,21 have signalled their
between EUR20-60 billion; financial
risks. Climate vulnerability is associated disquiet at continued investment into
institutions faced several billion euros'
with an increased cost of sovereign coal, echoing European banks' actions.
exposures to their balance sheets.14
borrowing. Sovereign bond issuers pay a There is a risk that schemes relying on
Many AMS have already experienced the
yield premium of around 275 basis ongoing project finance could
devastating effects of extreme weather.
points in highly exposed economies, 155 experience dramatic changes in financial
Events such as Typhoon Haiyan (2013)
basis points in South-East Asian terms, and a risk of stranded assets and
and Cyclone Nargis (2008) are increasing
economies, and 113 basis points for counterparty risks for local ASEAN banks
in frequency. With large populations and
emerging market economies overall. On (a risk they are starting to address; see
economies located in low-lying or below
the other hand, resilience to climate risk UOB’s, DBS’s and OCBC’s (Singapore)
sea-level locations, banks and insurers'
is statistically significant in reducing and CIMB’s (Malaysia) decisions to end
risks are clear.
bond yields worldwide, although with coal financing)22 and the manifestation
The longer-term, chronic physical much smaller magnitudes.18 of acute transition risks such as large-
impacts of climate change are equally scale write-downs of capital for stranded
malignant, even if their immediate assets.23
manifestations can at first appear more
benign. Irregular rainfall or temperature
Transition Risk Similarly, developments such as the EU
Sustainable Finance Taxonomy have
can reduce the output of economies Transition risks result from the transition provided Europe’s institutional investors
with large agricultural sectors. This can to a carbon-neutral economy and the with clear guidelines on how to measure
have material financial impacts in possible effects on the value of financial the alignment of their portfolios with the
industries such as fisheries and assets and liabilities. The transition to a Paris Agreement. As Paris Agreement-
agriculture. An International Panel on low-carbon economy will require aligned investing becomes normalised
Climate Change (IPCC) report on climate substantial upfront investment, through internal investor policies, the
change explains the impacts on key generating new commercial risk of stranded assets in ASEAN may
economic sectors and services.15 opportunities and redirecting capital increase.
The cost of chronic impacts is also flows away from certain previously
favoured assets, locations or modes of High dependency on oil exports will
manifest in the cost of protective efforts.
production (such as fossil-fuel-based leave Indonesia and other ASEAN
According to a study by Ng and
7
Embedding sustainability into the COVID recovery - Climate Bonds Initiativecountries vulnerable to changes in oil imports may require fossil fuel exporting outlined above. Mitigation efforts in
price. In their book Central Bank Policy: countries to rapidly contract fiscal South-East Asia to meet the goals of the
Theory and Practice, Bank Indonesia spending in line with the loss of state Paris Agreement (improving energy
Governor Perry Warjiyo and Solikin receipts – 22.6% of Indonesian efficiency, halting deforestation,
Juhro articulate how the discovery of oil government revenue came from fossil replacing carbon-intensive fuels) are
fields provided a windfall in state fuels 2011-2016, and Brunei’s oil and gas calculated by ADB to cost the region
receipts that could be used to stimulate industry contributes 60% of GDP.25 USD2bn /year or 0.6% combined ASEAN
economic activity through fiscal GDP. However, these high costs should
Due to the uncertainties over transition
spending.24 However, the additional be compared to the cost of inaction –
pathways and policy choices, the
export revenue, which expanded the under a global business-as-usual
financial cost of transition is challenging
total money supply, also required a scenario, South-East Asian GDP is
to calculate. Adaptation investment
reflective monetary expansion to absorb predicted to contract 11% by 2100.26
needs for ASEAN will be significant due
excess liquidity that could otherwise
to the high physical risk exposure
have driven inflation. Reduced oil
8
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeHow Central Banks Can Build Back Better
The preceding sections laid the Managing Climate and Environment- Figure 4 for those which can best
foundations for understanding how related Risks (the Taskforce Report) incorporate sustainability. Individual CB’s
COVID-19 has impacted financial stability outlines, sustainable or socioeconomic responsibilities will vary depending on
and how the ensuing crisis is also an development is often a secondary the exact remit. Instruments highlighted
opportunity to reconsider monetary objective for ASEAN Central Banks.27 in orange are those most relevant to the
policy from a sustainability perspective. COVID-19 response. Those in grey are
ASEAN Central Banks’ broad mandates
This section outlines the tools that are less relevant to this discussion paper.
allow them to pursue development
being used to respond to the pandemic
initiatives and shape broad national In the context of the COVID-19
by central banks and proceeds to
policy objectives, several have also pandemic, central banks’ main roles
suggest a method through which
developed sustainability strategies or have been to provide monetary stimulus
sustainability can be incorporated into
frameworks, which enables to safeguard the stability of the financial
specific policies and tools.
mainstreaming of sustainability in wider system, support fiscal stimulus through
This is positioned considering ASEAN operations. Furthermore, even central purchasing government debt and
Central Banks’ mandates, which require banks which do not have explicit or directly stimulate real-economy activity,
them to: implicit sustainability objectives can still for example, through corporate asset
consider climate-related physical and purchases. Most of the measures and
• keep inflation below a target level,
mitigation risks when executing their instruments outlined in Figure 2 have
• manage the exchange rate,
roles in safeguarding the economy.28 been used in response to the pandemic
• ensure financial stability by monitoring
to maintain liquidity and credit flows.
systemic risks, and Central banks have a range of monetary
The emphasis has been on enabling the
• supervise individual banks and prudential policies at their disposal
continued functioning of the real
(implementing BASEL III) and insurers to help fulfil these mandates. Figure 2
economy. This is shown by the SME
to ensure they are operating within below depicts the tools available to
weighting of several instruments across
the prudential framework. them and how these interact with the
the world.29 These measures are also
national government’s fiscal policy.
As the ASEAN Taskforce’s Report on the designed to complement or support
Figure 2 highlights the tools commonly
Roles of ASEAN Central Banks in governments’ fiscal policies.
used in the COVID-19 response; see
9
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeFigure 2: Conceptual illustration of the role of central banks and
supervisors, showing interaction with fiscal policy.
a case-by-case basis.32 The capital
Prudential Policy during Microprudential Regulation conservation buffer (CCB), which stands
COVID-19 39% of CBs have loosened at 2.5% of risk-weighted assets, has
microprudential regulations in response been reduced by nine CBs. Whilst
Prudential regulation under the Basel to the pandemic, according to Dikau et facilitating liquidity flows and ease of
Agreement ensures that banks have al.’s ‘Toolbox of Sustainable Crisis lending, this can increase risk exposures
adequate Tier 1 capital (chiefly bank Response Measures for Central Banks – many banks have set expectations for
equity and retained earnings) to finance and Supervisors’ (2020).30 This can be the use of the additional capital from
their exposure to loan losses and enacted quickly, increasing commercial these buffers; to support the economy
enough liquidity coverage (easily banks’ liquidity allowing them to and not for capital distributions
liquidated assets such as government continue providing credit to their (dividends and share buybacks). This
bonds) to meet their borrowers’ typical customers. The Banco Central do Brasil follows Basel standards which dictate
near-term funding needs. During the relaxed the capital requirements for that banks that do not maintain their
pandemic, there has been a loosening of smaller FIs; their modelling suggested CCB standard will face automatic
prudential requirements by central this potentially releases BRL1.3bn of constraints on income and dividend
banks to avoid the withdrawal of liquidity that may allow up to BRL16.5bn distributions.33
liquidity and sharp reduction in inter- in credit provision.31 The Banco Central
bank lending that occurred during the Many regulators have asked banks to
de Chile made liquidity regulations more
GFC. curtail payments of dividends and
flexible by expanding the eligible
discretionary bonuses to senior bank
currencies for meeting foreign currency
staff until the end of 2020 and to
reserve requirements and relaxing the
increase the available Tier 1 capital
liquidity coverage requirement (LCR) on
10
Embedding sustainability into the COVID recovery - Climate Bonds Initiativeneeded to provide for any increase in Macroprudential Regulation among ASEAN CBs, with some such as
losses in the real economy. Bank Indonesia holding it at zero prior to
Loosening macroprudential regulation
the crisis, whereas others held 2.5%
has been used by 21% of CBs during the
buffers to draw down on.38
crisis, according to Dikau et al. (2020).36
Applicability for Build Back Better:
Commercial banks and other FIs are Dikau et al. (2020) warn that such
To direct liquidity flows to the most required to hold capital buffers directly countercyclical release can be
sustainable activities, central banks can proportional to the size and riskiness of potentially environmentally damaging
vary capital requirements according to their lending activities – the since the new bank lending engendered
an FI’s climate risk exposure. Capital Countercyclical Capital Buffer (CCyB) by the increase in available capital is not
buffers would be set higher for those aims to protect the banking sector from necessarily directed at sectors most in
with greater exposure to unsustainable periods of excess aggregate credit need.39 This can be countered by
activities because these FIs would be at growth that have often been associated excluding or penalising lending to
greater risk of default. Conversely, with the build-up of system-wide risk. Its sectors with the highest transition risk.
capital requirements could be countercyclical nature makes the CCyB This raises the wider issue of climate
discounted according to an FI’s green the easiest to deploy in a crisis; CBs can risks not being adequately priced into
lending. In 2019 the Hungarian central decrease the level of the CCyB economic risk management – an issue
bank, Magyar Nemzeti Bank (MNB), did immediately to maintain the flow of that is beginning to be addressed by
so, announcing a preferential capital credit in the economy.37 Figure 3 shows climate disclosures and stress testing.
requirement against balance sheet the widespread and coordinated efforts
exposure to energy-efficient housing by many central banks to reduce the
loans.34 The discount reflected the capital buffer by between 0.5% and 2%
reduced risk of default on green in the first two quarters of 2020 to
mortgages.35 increase capital availability. CCyBs vary
Figure 3: Effective CCyB rates before and after the COVID-19 Shock
Source: Adapted from Reinhardt & Hombeeck (2020) With a little help from my friends40
Applicability for Build Back Better information needed to measure and resilience to banks or setting exposure
manage such risks. When developing restrictions for certain assets or
Regulators wishing to safeguard
these datasets, priority should be given sectors.41 Risk weighting of assets can be
macroprudential stability should
to sectors and organisations that are made more sensitive to climate risk by
calibrate regulatory instruments to
most material. New macroprudential giving higher risk weightings to exposed
account for systemic financial risks like
instruments can be leveraged to reduce sectors or by reducing risk weighting of
climate-related risks. This can be
risks identified by stress tests, such as green assets, as done by the People’s
informed by using climate scenarios in
the implementation of a countercyclical Bank of China (PBOC)42
improved stress testing and disclosure
carbon capital buffer, acting similarly to
requirements; see below. FIs, and their Increasing prudential involvement in
the CCyB to give climate-sensitive
counterparties, will need time to collect policy could also take the form of
11
Embedding sustainability into the COVID recovery - Climate Bonds Initiativeensuring that current regulation does refineries, much worse than the cost The term “direct” refers to the one-to-
not have unintended consequences on increase from COVID (although French one correspondence between the
the financing of low-carbon transitions. banks have relatively little exposure to instrument (such as a credit ceiling to a
For example, Basel III stipulates a higher such sectors).52 Climate stress tests sector) and the policy objective (such as
capital requirement for long-term credit, would also provide supervised banks and restricting domestic credit into the
which disproportionately impacts FIs with actionable information to sector).56 Direct instruments set or limit
sustainable finance projects.43 recalibrate their lending decisions. either prices or quantities through
regulations and may also be used to
ASEAN CBs are making progress on
allocate credit, and can include:57
disclosure requirements. Bank Negara
Stress Testing Malaysia (BNM) recently introduced • Direct controls on interest rates (e.g.,
disclosure requirements for commercial minimum and maximum interest
Many central banks have delayed or
banks.53 Bangko Sentral ng Pilipinas’s rates, preferential rates for certain
adjusted regular microprudential stress
(BSP) 2020 Sustainable Finance loan categories).
testing to limit the immediate regulatory
Framework introduced disclosure • Credit ceilings (at an aggregate level or
burden on banks and FIs. Central banks
requirements for supervised banks – on on individual banks).
are expected to resume full macro- and
their sustainability strategy, finance • Directed lending policies (e.g.,
microprudential stress testing this year.
activity, environmental & social risk preferential central bank refinance
The delay may have allowed time for the
management system, risk exposures and facilities to direct credit to priority
evaluation of stress testing’s coverage;
impacts and sustainability initiatives.54 sectors).
in November, the Bank of England (BoE)
However, ASEAN FIs currently show a • Window guidance/moral suasion to
and the UK Treasury announced
relative lack of disclosure and progress promote priority sectors.
mandatory climate disclosures for most
on portfolio level climate scenario
financial institutions by 2025,44 in line On the other hand, indirect monetary
analysis; this may increase liquidity
with the recommendations of the policy tools such as open market
risks.55 Following the TCFD
Taskforce on Climate-related Financial operations (OMOs) and standing
recommendations, mandating climate
Disclosures (TCFD).45 facilities operate through the money
risk disclosures as the BoE has done will
market and can be described as market-
Several CBs (European Central Bank, allow supervisors to monitor climate risk
based instruments. These are explained
BoE) carried out ad hoc, exposure more comprehensively and
in more detail below. Nonstandard
macroprudential stress testing in discuss how these risks are managed.
policies of asset purchase and
response to the crisis.46 These tests were
A key difference between climate risks quantitative easing have also swelled
used to inform monetary and prudential
and many other credit risks are that the central bank balance sheets across the
policy responses.
future liabilities are informed by world.
forward-looking climatic/energy risk
A recent NGFS report, Adapting central
models rather than backwards-looking
Applicability for Build Back Better: bank operations to a hotter world, sets
analysis of outturns from credit risk. In
out a framework and assesses the
Central banks can take this opportunity the long term, results from climate risk
feasibility of how central banks could
to integrate climate into both their models could inform risk-weightings and
apply their monetary policy operations
macro and microprudential stress capital allocation.
to manage climate risks.58
testing regimes. Climate stress testing
allows CBs to evaluate the system’s risk
exposures and increase resilience to
possible acute physical and transition
Monetary Policy during Indirect Monetary Policy
shocks in the future; it can also inform COVID-19 Instruments
the CB’s capital requirements and
To increase the real economy’s access to Open market operations are an active
monetary policy. Climate stress tests
finance and also reduce the cost of method of liquidity supply, initiated by
have been announced by the European
finance, central banks have used the central bank and offered to a wide
Central Bank (ECB),47 BoE,48 Banque de
monetary policy instruments to expand range of counterparties but settled
France49 and Monetary Authority of
liquidity and credit supply in the through open auction mechanisms. In
Singapore (MAS).50 Such stress tests
economy. Central banks can implement contrast, standing facilities provide
could apply the NGFS’s recently
monetary policy directly through their passive liquidity supply in a bilateral
published scenarios to assess banks’
regulatory powers or indirectly by arrangement agreed between the
exposure to climate mitigation and
influencing money market conditions as central and commercial banks.59 Dikau et
physical risks over a long (30 year) time
the issuer of central bank money al. (2020) found 48% of central banks
frame.51 The ACPR asked French banks
(currency in circulation and balances have used indirect monetary policy
and insurers to undertake climate stress
with the central bank). Whilst direct instruments such as OMOs and standing
tests using the NGFS scenarios. The
policy is more frequently used in facilities in their COVID-19 response.60
results from the disorderly transition
scenario suggest a three-fold rise in the emerging market economies, both types
cost of risks for sectors like mining and can be used concurrently.
12
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeOpen Market Operations CBs have established innovative standing Collateral Frameworks
facilities to facilitate recovery. This is
During open market operations, the CB Changes to the collateral frameworks
shown by the increased funding-for-
lends short-term to FIs to change the were used in 29% of responses analysed
lending outlined above. In November,
commercial banks’ offered interest by Dikau et al. (2020).70 This entails
the BoJ introduced the special deposit
rates. OMO responses include PBOC reducing the haircut so that more can be
facility to tackle the declining
injecting RMB3.33 trillion (gross) borrowed for the same collateral or
profitability of regional banks. Those
liquidity into the banking system via expanding the range of assets that are
that announce mergers or acquisitions
OMOs (reverse repos and medium-term eligible to be used as collateral. For
are rewarded with higher interest rates
lending facilities)61 and the Bank of example, the Banco Central de Chile
of 0.1% (rather than -0.1%) in the special
Korea’s (BoK) provision of unlimited expanded its framework to include
deposit facility. This measure is likely to
OMO liquidity via a weekly repo facility corporate securities as collateral for its
spark long term restructuring of the
at set interest rates.62 liquidity operations and high-rated
sector.69
commercial loans as collateral for
Longer-term refinancing operations
funding facility operations. The ECB
(LTROs) are used to support liquidity
temporarily reduced its haircut by 20%
requirements and reduce sovereign debt Applicability for Build Back Better:
in its LTRO facility, increasing its risk
yields. The ECB has introduced
If these instruments for stimulating the tolerance to aid the Eurozone
additional LTROs to meet liquidity needs
real economy are calibrated without economy.71 Other CBs have made similar
and support euro market operating,
sustainability considerations, they could adjustments – the Bank of Korea’s
followed by pandemic emergency
potentially lead to a build-up of more collateral ratio has been lowered from
longer-term refinancing operations
assets with high carbon bias, further 70% to 50%, alongside a broadening of
(PELTROs) with an interest rate 25 basis
increasing FI’s exposure to transition eligibility.
points below the average refinancing
risks on their balance sheets. Indirect
rate, providing additional longer-term
monetary policies could support the
financing to banks.63 These have been
reduction of climate-related risks Applicability for Build Back Better:
continued into 2021 due to the
through the exclusion or tilt against
resurgence of the pandemic.64 Expansion of collateral frameworks to
climate/transition risk exposed assets
include green assets can be used to
from the schemes. For OMOs, which are
incentivise sustainable investment.
used in many AMS, climate
Standing Facilities MAS’s new Term Facility accepts
consideration could be integrated into
residential property loans72 as collateral
Standing facilities have been widely used the benchmark allotment that FIs can
from certain banks. This facilitates
to target financial support to specific access through these operations. This
increased lending to households and
sectors, specifying how money from the approach could also be used in
corporates,73 demonstrating how
facility should be lent on. BoK refinancing and liquidity operations by
targeted action on collateral frameworks
established a Corporate Bond-Backed other monetary bodies.
can change finance markets. The ECB
Lending Facility, a standing lending
Both standing facilities and open market recently expanded its framework to
facility that allows ready access to credit
operations can also be made more accept sustainability-linked bonds as
using eligible corporate bonds as
sustainable through changes to collateral for Eurosystem credit
collateral.65 The Bank of Japan’s (BoJ)
collateral frameworks. Collateral operations and asset purchases.74
Special Funds-Supplying Operation
frameworks determine the weights and
facilitates SME financing.66 Further Furthermore, the exclusion of assets
eligibility of different assets for use as
incentivisation was provided by with high climate risks as acceptable
collateral for short-term lending by CBs
expanding eligible collateral to include collateral can also help to reduce the risk
to FIs. Short term-lending supplies
‘private debt’ and applying a favourable to a central bank’s balance sheet.75
liquidity to the financial system and
interest rate to FIs’ current account Negative screening is one of the most
transmits changes in the policy interest
balances corresponding to loans common sustainable portfolio
rate. Haircuts are applied to the face
provided. The BoE introduced the “Term management tools used by central banks
value of the asset to adjust the amount
Funding Scheme with additional and is used chiefly in CB’s equity
the CB will lend the FI, reflecting the
incentives for SMEs” (TFSME) in which holdings.76 In addition to positive and
liquidity and riskiness of the asset. Entire
lending to SMEs generated greater negative screening, haircut adjustments
classes of assets can be added or
borrowing allowances, reinforcing can be made to better account for
withdrawn from the list of eligible
transmission of low-interest rates to the climate-related risk. The NGFS (2021)
assets.
real economy.67 The increasing numbers Hotter World report suggests the most
of CBs introducing term funding impactful haircut adjustment to be one
schemes show they are widening their that uses a sliding scale to penalise and
toolkits and turning their attention to reward issuers according to their
the longer term.68 climate-related riskiness, with minimal
consequences for monetary policy
As the pandemic has progressed and
effectiveness.77
horizons have shifted to the long term,
13
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeDirect Monetary Policy GFC programmes81) to supply short term enough flexibility to ease the burden of
Instruments funding. BoJ doubled its CP and reporting, there is potential for the CB to
corporate bonds purchases relative to influence risk awareness and
Direct instruments have seen
the GFC, while BoE established a management in the real economy.
widespread expansion during the
purchase programme ten times larger
pandemic as CBs maintain liquidity flows
than that of the GFC.82 They have also
to the real economy.
been used in a targeted fashion to assist
Non-Standard Instruments
priority sectors. The Central Bank of
Nigeria provided N150bn of targeted During the pandemic, central banks (and
Reserve requirements
credit facilities for households and SMEs; other investors) have been asked to
Reserve requirements can be reduced, priority was given to lend to businesses greatly expand purchases of government
thereby increasing the funds available to in the health sector.83 and corporate bond issuances into their
banks for lending. Normally these are set quantitative easing (QE) or asset
There is an interesting example of one
in a market-neutral approach with a purchase programmes (APPs). At least
(albeit government rather than central
percentage of all customer deposits 18 central banks have carried out asset
bank operated) instrument used to
being placed with the central bank. But purchases in their responses.88 Such
reduce climate mitigation risks. Canada’s
lower reserve requirements could be action provides immediate liquidity,
Large Employer Emergency Financing
applied to the desired form of lending.78 indirectly funds fiscal policy and restores
Facility (LEEFF) provides 5-year bridge
To increase MSME’s access to credit investor confidence.89 These non-
loans of CAD60m and above.84 Access to
during the pandemic, the Banco Central standard instruments expand the central
the LEEFF requires companies to submit
do Brasil allowed FIs to deduct up to bank’s balance sheet by increasing the
TCFD-related disclosures of their
30% of their reserve requirements on money supply to buy up high-quality
climate-risk strategies, limits executive
deposits used to provide credit to financial assets (government and some
pay rises, and the loans are subject to a
MSMEs, which they project expands commercial bonds) from the secondary
high interest rate. Uptake has so far
lending to MSMEs by BRL 55.8 billion.79 market. QE is used to boost the
been limited (two loans approved in
economy through credit creation when
2020 and three in 202185) since finance
the bank rate cannot be further
is also available to firms through the
Applicability for Build Back Better: reduced. Because of the near-zero
Bank of Canada’s asset purchasing
interest rates in many OECD countries,
Differentiated reserve requirements, as programme on less onerous terms.86
QE programmes have been expanded.
applied to MSMEs in the initial response, This demonstrates the need for more
The BoE holds GBP895bn90 under its
could be used to direct recovery thought and consistency across
Asset Purchase Facility. The ECB’s
spending towards more sustainable measures if CBs want to take the
Pandemic Emergency Purchase
lending. For example, Lebanon’s CB, opportunity of the current upheaval to
Programme holds EUR1,034bn (as of 7th
Banque du Liban, differentiates reserve embed environmental considerations
May 2021).91 Other central banks have
requirement ratios according to the into operations.
established APPs in response to the
amount of bank lending flowing to
pandemic. BSP has directly purchased
renewable energy and energy efficiency
PHP300bn of government securities
projects.80 Applicability for Build Back Better:
(about 1.5% of GDP) through a
The targeting of corporate financing repurchase agreement and purchased
facilities to certain industries PHP500bn on the secondary market,
Corporate financing facilities
demonstrates their suitability for totalling 45% of the country’s domestic
Corporate financing facilities provide targeting sustainable sectors in the borrowing.92 Similarly, in April, Bank
businesses with money on a short-term recovery effort. The Reserve Bank of Fiji Indonesia made its first primary market
basis without any need for collateral. has, to date, been the only CB to purchases of government securities at
These provide liquidity directly to the explicitly calibrate a monetary response IDR4.65trn (USD302m).93 The Bank of
real economy and can be targeted to to sustainability in expanding the Import Papua New Guinea also has a
specific industries, making them well Substitution and Export Finance Facility, programme.94 Primary market
suited to a crisis that has which provides credit at concessional purchasing (monetary financing) is not
disproportionately impacted SMEs and rates to certain businesses, including permitted in many central banks as it
industries such as the hospitality and renewable energy businesses.87 increases the risk of heightened inflation
transport sectors. – secondary market purchase is more
Despite the low uptake of the LEEFF,
widely used.
Corporate financing facilities and attaching disclosure requirements to
commercial paper (CP) purchase facilities should not be discounted as a
increase the debt holdings of the central way to stimulate sustainable investment.
Applicability for Build Back Better:
bank. As commercial paper markets If such requirements are attached
froze across the world, many CBs consistently to all financing facilities There is the potential for a sustainability
established emergency commercial (rather than lenders of last resort) focus in the types of bonds purchased in
paper purchase programmes (or revived offered by the CB and government with QE programmes. As part of its COVID-19
14
Embedding sustainability into the COVID recovery - Climate Bonds Initiativeresponse, Sweden’s Riksbank expanded the highly fossil fuel-exposed provinces policies. CBs must recognise and reflect
its SEK700bn (USD82bn) QE programme of Alberta in Canada and Queensland the growing understanding of climate
to include sovereign and municipal and Western Australia.96 QE is a less risk in their innovative crisis intervention
green bonds. Separately, it made common CB practice in ASEAN. But and recovery efforts. All aspects of CB
inclusion in its corporate bond QE these considerations could be used by monetary and prudential policymaking
programme conditional on issuers Indonesia and the Philippines that could be tilted to mitigating climate
complying with sustainability engage in QE or Singapore that holds risks, and we would argue that there are
standards.95 In 2019, Sweden’s Riksbank foreign corporate bonds.97 substantial long-term societal benefits to
also applied climate risk-weightings to a considering these opportunities.
Ultimately, recovery efforts must align
portion of its SEK500bn forex reserves.
with longer-term CB and government
This resulted in it excluding bonds from
15
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeConclusion
This paper aims to identify the tools We very much agree with the findings of bank’s toolkit, certain policies are likely
used during the COVID-19 pandemic, the ASEAN Taskforce Report, which to be more impactful and easier to
which are the most suitable for climate- called for the banks, under the behest of implement over the next few years.
risk mitigation and can be most easily central banks, to supply actionable Figure 4 below identifies our assessment
repurposed. CBs’ response to COVID-19 information regarding their exposure to of the policies and tools used by central
has showcased their capacity for fast, climate-related financial risk so they may banks which could be repurposed to
innovative action. Policies used by CBs better manage it. But even whilst mitigate climate risks over the near
during the pandemic - to protect gathering this information, central banks term. Individual CB’s responsibilities will
businesses, maintain economic stability can still take ‘no regrets’ actions to vary depending on the exact remit.
and stimulate recovery - could protect enhance sustainability through their Instruments in green have a high
AMS from future systemic risks – policy toolkit. potential for incorporating sustainability
particularly climate risks. factors.
Whilst sustainability considerations can
be applied to almost all of a central
Figure 4: Conceptual illustration of the role of central banks and
supervisors, showing interaction with fiscal policy.
16
Embedding sustainability into the COVID recovery - Climate Bonds InitiativeShort-term collateral and ensure these assets, and Medium-term
the currency/economic system they
As referred to above, introducing In the medium-term (the next 2-5 years),
support, are resilient to and not
disclosure requirements is an immediate many central banks and regulators plan
worsening future climate and transition
priority for central banks looking to to require greater disclosure of climate
risks. Some countries (like France) have
develop their understanding of climate- risks in their countries’ financial systems.
tied rescue package in high emissions
related risks. These can be developed in This will be both for individual banks and
sectors, like aviation, to help long-
collaboration with governments to the entire financial system’s exposure
distance domestic transport make modal
ensure alignment with corporate using forward-looking risk assessments.
shift from aviation to rail to help
disclosure requirements. Other ASEAN
transition to a lower emissions Climate-risk scenarios and climate-
CBs could follow the example of BNM,98
economy.104 This Just transition policy related stress tests (already being taken
MAS99 and BSP100 for their introduction.
balances the socioeconomic need to forward in Singapore) are an important
The ASEAN Taskforce Report indicates retain employment in important sectors medium-term policy in the prudential
that prudential action is more palatable to their reform. regulation toolkit. They are a departure
to central banks than the ‘greening’ of from risk managers’ usual analysis based
For this reason, in Figure 4, we suggest
monetary policy due to the lack of on historical data and instead model
ASEAN Central Banks investigate
evidence and precedent for such future risks using a range of plausible
whether:
actions.101. However, monetary policy climate-risk scenarios in anticipation of
tools played an important role in CBs’ • open market operations are tailored to these events. The data and models are
response to the pandemic crisis both support bank lending (both short and still being developed. Still, the stress
globally and within ASEAN102 and could medium-term) targeted specifically to tests can be iterated and improved over
play a vital role in tackling the climate businesses that reduce climate risk time as the evidence base and tools
crisis. One important matter is ensuring exposure; become more available and more
that liquidity provision through asset • haircuts and asset eligibility for sophisticated. The results will provide
purchases and collateral frameworks do collateral could be reviewed through a central banks with quantitative insights
not increase climate-related risk climate-related risk lens; into the comparative risks faced by
exposure. Better still, they should • corporate financing facilities, where different financial institutions within an
encourage investment in sustainable the CB buys equity or bonds directly economy and can be used to set
alternatives – the NGFS (2021) has from issuers, could also be tilted to prudential guidelines. Where possible,
suggested positive collateral screening encourage green investment. results from these risk assessments
and tilting asset purchases to be among should be published – perhaps based on
Adjustments to collateral frameworks
the most impactful measures in climate TCFD recommendations.
may reduce the volume of central bank
mitigation.103
lending to banks, and so must be Beyond disclosure, research needs to be
There is also a risk that fiscal stimulus individually assessed. However, the done in testing the efficacy of using
packages introduced by the government NGFS suggests the implications for prudential regulation concepts such as
and supported by central banks (through monetary policy effectiveness of the climatic-systemic risk buffers. These
their purchase of government debt) to options suggested above may be capital requirements could be calibrated
rescue businesses could worsen physical negligible compared to more stringent according to the climate risks on banks’
climate or transition risks. CBs should exclusionary policies105 and therefore balance sheets and so provide a
examine the climate-related risk of the easier to implement. sophisticated approach to climate-
assets they buy for policy purposes like related risk mitigation.
exchange rate management or accept as
17
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