Friday, May 27 2022

Compelling academic articles

The Global Research Alliance for Sustainable Finance and Investment is a collaboration of universities committed to producing high-quality, interdisciplinary research and teaching programs in sustainable finance and investment. In this series, we highlight compelling papers presented at the last GRASFI conference, with commentary from a BNP Paribas Asset Management ‘practitioner’.

As the sustainable investor for a changing world, BNP Paribas Asset Management supports GRASFI’s efforts to bring academic rigor to the challenges of sustainable finance and investment. Thanks to its sponsorship, BNPP AM can access cutting-edge academic research on sustainable finance and investment, helping to inform the wider debate. Our goal is to share these thoughts with customers and the industry. Visit the GRASFI conference website.

The European Commission is disengage that “improved measurement and modeling of the impacts of climate change on financial stability is needed” and that central banks must do more to manage their exposure to environmental risks.

In the newspaper CARO: refinancing operations adjusted to climate riskauthors [1] note that since the global financial crisis of 2007/08, central banks have increasingly resorted to targeted refinancing operations (providing central bank money to credit institutions) to achieve their general objectives, such as improvement of liquidity conditions in the financial system.

According to Economic Policy Council (CEP), “none of them, with a few exceptions in developing economies, have aligned their targeting with the goal of a transition to a low-carbon economy”.

The authors argue that central banks can use climate risk-adjusted refinancing operations (CAROs) to direct bank lending to low-climate-risk projects.

Climate risks in financial markets and bank lending decisions

Several policymakers pointed out that climate risks may not be properly priced by financial markets and financial intermediaries due to subjective beliefs about climate change and associated physical and transitional risks.

As the authors put it: “From the point of view of a central bank, without intervention, the different beliefs of private agents lead to an allocation of resources in the decentralized equilibrium that is suboptimal.

If the central bank believes that a sector is more exposed to climate risk than private agents, it can decide to influence, for example, banks’ lending decisions.

One option is to condition banks’ borrowing costs for central bank liquidity on the climate risk exposure of individual asset portfolios. This spills over to the real economy through higher (lower) financing costs for companies that are more (less) exposed to climate risk.

The authors say that with the optimal design of its facilities, the central bank can always induce the optimal allocation according to its beliefs about climate risk.

CARO – Refinancing operations adjusted to climate risk

The paper studies a climate-focused monetary policy where the central bank uses differentiated interest rates in its refinancing operations that depend on the climate risk exposure of an individual bank’s assets. Monetary policy operations are also analyzed in an environment characterized by private and public agents with different beliefs about climate risk.

The newspaper asks three questions:

  1. What are the implications of differences in belief between private agents and the government for the real economy?
  2. From the central bank’s point of view, what is the optimal monetary policy in the presence of such differences?
  3. How is optimal monetary policy affected by climate risk mitigation, concerns about financial instability, and climate-related goals?

The authors found that the central bank can “completely eliminate the distortion of belief-based loan allocation and induce the allocation that would appear if private agents shared the beliefs of the government and the central bank did not intervene” using OARCs.

If agents attach a lower probability to the transition than the government, the optimal marginal liquidity cost factors set by the central bank are higher for the risky sector than for the risk-free sector. The article shows that the intensity of central bank intervention, measured by the absolute difference in marginal cost factors, increases with differences in belief between private agents and the government.

The authors write: “A policy of differentiated interest rates on reserves allows the central bank to influence the allocation of loans in the economy, through liquidity costs for banks. For example, if the government finds the transition more likely to occur, compared to private agents, the central bank can counteract the belief effect on loan allocation by setting higher marginal liquidity costs for allocated loans. those most exposed to climate risk. sector.”

The authors also promote the use of Climate Risk Mitigation Technologies (CRMTs), taking financial stability concerns into account and presenting climate-related allocation targets.

They say, “We find that CRMT investing decreases the need for the central bank to intervene, regardless of the beliefs of private agents and government.”

Although the authors support CORAs as a way to manage climate risk in the financial system and encourage lending to sectors that have the potential to mitigate environmental damage, they concede that more research is needed in this area.

The paper concludes: “Our analysis is a first attempt at a formal analysis of central bank refinancing operations taking climate risk into account. As with CORAs, the pricing of central bank reserves may be conditional on other characteristics of bank assets.

Commenting on the document, Richard Barwell, head of macro research at BNP Paribas Asset Management, said: “The paper illustrates how central bank refinancing operations could be adjusted for climate risk to help steer the economy down a path to net zero. However, that’s not because you can. It is not obvious why central banks should impose taxes and subsidies in the pursuit of allocative efficiency This task is usually left to elected politicians. such as CAROs, there is an important debate to be had around the role of central banks in promoting the low carbon transition.

The references

[1] Florian Boeser and Chiara Colesanti Senni


All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. The opinions expressed in this podcast do not constitute investment advice.

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