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NGFS Offers Climate Risk Guidance for Central Bank Monetary Operations

Technical document outlines options for central banks to adjust their operational frameworks for monetary policy to account for climate-related risks.

The Network for Greening the Financial System (NGFS), a group of 89 central banks and financial supervisors formed to support the Paris climate goals, has published a report outlining options for central banks to factor climate-related risks into their monetary operations.

“Under all possible scenarios, climate-related risks will have consequences for the economic outlook, for the financial system in which central banks operate and, thus, for the conduct of monetary policy,” the report says. “The timing and severity of these consequences depend on how swift and effective transition policies are.”

Climate-related financial risks may directly impact both central banks’ counterparties and financial assets used in monetary policy operations, and can also generate financial losses for central banks’ balance sheets.

“In extreme cases, climate-related shocks can affect the smooth implementation of monetary policy by exposing various monetary policy transmission channels to the impacts of physical and transition risks,” the report says.

The report proposes nine ways central banks may adjust their monetary policy operational frameworks to account for climate-related risks across three areas.

In credit operations:

  • Adjust interest rates for central bank lending facilities to reflect the extent to which a counterparty’s lending is contributing to climate change mitigation and/or the extent to which they are decarbonising their business model
  • Adjust interest rates to reflect the composition of pledged collateral in low-carbon (or carbon-intensive) assets or set up a credit facility accessible only against low-carbon assets
  • Adjust counterparties’ eligibility to some lending facilities conditional on their disclosure of climate-related information or on their carbon-intensive/low-carbon/green investments

In collateral operations:

  • Adjust haircuts to better account for climate-related risks, or calibrate them such that they go beyond what might be required from a purely risk mitigation perspective in order to incentivise the market for sustainable assets
  • Exclude otherwise eligible collateral assets, based on their issuer-level climate-related risk profile for debt securities or on the analysis of the carbon performance of underlying assets for pledged pools of loans or securitised products
  • Accept sustainable collateral so as to incentivise banks to lend or capital markets to fund projects and assets that support environmentally-friendly activities
  • Require counterparties to pledge collateral such that it complies with a climate-related metric at an aggregate pool level

In asset purchases:

  • Skew asset purchases according to climate-related risks and/or criteria applied at the issuer or asset level
  • Exclude some assets or issuers from purchases if they fail to meet climate-related criteria

The report says central banks can benefit from maintaining engagement with developing ideas in the operations space, including through participation with the NGFS.

“Closer cooperation is likely to be valuable amongst regional groups, and among central banks with similar operational frameworks. However, central banks should remain at liberty to move at a pace suited to their jurisdiction, while remaining mindful of the spill overs of their decisions, and learning lessons from the experience of early adopters,” it says.

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