How “green” are bank policies to speed economic recovery?
Programmes by the European Central Bank (ECB) and Bank of England designed to boost economic growth after the 2008 financial crash could inadvertently be giving high-carbon sectors an advantage over their low-carbon counterparts. These measures, including quantitative easing, may be coming to an end, but their ‘high-carbon skew’ could have a long term impact on the UK and Eurozone.
Under quantitative easing (QE) programmes, the ECB and Bank of England inject money into the European and British economies by buying assets. Last year the central banks began buying corporate bonds under these programmes. Our new analysis suggests that they have made the bulk of these purchases in the two most carbon-intensive sectors: utilities and manufacturing.
This could be bad news for low-carbon sectors. Though the schemes, which are worth £10 billion at the Bank of England and €82 billion at the ECB, are not designed to give any particular corporations an advantage, the system does not work perfectly. The evidence suggests that the owners of purchased assets benefit more.
A closer examination of these QE corporate bond purchases provides an opportunity to reflect on both the structural problems in the financial sector that disadvantage low-carbon investment, and on how central banks can align their policies with the shift to a low-carbon economy without exceeding their remit.
ECB and Bank of England quantitative easing programmes disproportionately favour high-carbon sectors
Central banks try to steer the economy towards a stable rate of growth using monetary policy. They usually do this by purchasing public sector (Government) bonds. However, under QE, central banks have also purchased other types of financial assets, such as private sector stocks and bonds.
It is not always easy to assess the ‘greenness’ of the purchases of these types of assets because central banks restrict the information they publicly disclose about them.
Corporate bonds, on the other hand, offer a chance to take a deeper look at what the ECB and the Bank of England have been purchasing.
Based on information published on their websites, we estimate that the sectors of manufacturing and electricity production alone, which contribute 58.5%of Eurozone area emissions, make up 62.1% of ECB corporate bond purchases. But the size of the purchases does not reflect the total size of the sectors – they only represent 18% of Gross Value Added (GVA).
For the Bank of England, manufacturing and electricity production, which produce 52% of UK emissions, make up 49.2% of the ‘benchmark’ group of assets the Bank of England uses for purchases. Again, they contribute relatively little to the economy – only 11.8% of GVA.
Skew to high-carbon could be due to the make-up of the bond market and the eligibility criteria set by the central banks
Rather than a concerted effort to support carbon-intensive industries, this high-carbon skew seems to be strongly tied to the make-up of the UK and Eurozone economies, which have relatively too much invested in high-carbon assets compared with their low-carbon counterparts, and the eligibility criteria that governs which bonds can be bought under QE programmes.
‘Green’ bonds (which are not represented at all in ECB and Bank of England purchases) make up only a very small portion of the EU bond market. This is in part because of the barriers to green bond issuance and the funding structures for renewable energy projects.
In addition, the eligibility criteria for purchases also exclude some of the very small number of renewable energy companies in the corporate bond market, for example because they do not have a high enough credit rating due to a lack of sufficient credit history or uncertainty about future energy prices and renewable energy policy. Vestas Wind Energy A/S, for example, is the largest manufacturer of wind turbines by capacity globally, but it does not have a credit rating from any of the three major credit ratings agencies.
QE programmes are winding down but the high-carbon skew could affect borrowing by carbon-intensive sectors in future
The ECB and Bank of England have been buying corporate bonds in order to encourage companies to borrow more money and invest the proceeds. By making the bulk of purchases in manufacturing and utilities, the central banks might inadvertently be pushing up the demand for, and hence price of, these assets – potentially contributing to asset mispricing (i.e. a carbon bubble) – and encouraging additional borrowing in these sectors.
For example, oil and gas companies rely heavily on debt because they invest in long-term infrastructure with large upfront costs. There are concerns about whether the current levels of debt held by these companies are financially sustainable given the uncertainty about future oil and gas prices. Purchases of oil and gas company bonds could result in them borrowing more debt cheaply, leading to more investment in long-term infrastructure, and hence possibly contributing to a carbon bubble.
So even if QE is coming to an end, there could be long-term effects that prolong the status quo of over-investment in high-carbon infrastructure.
The central banks can continue to play a role without compromising their remit
At present, the central banks consider it to be outside of their remit to take account of climate change risks in their day-to-day operations. This must change in future if monetary policy is to be aligned with the transition towards a low-carbon world.
What is more, the banks can do this without compromising their remit. The Bank of England and ECB’s primary objectives are to maintain stable rates of inflation, but they are also supposed to support the economic objectives of their respective governments and monitor financial stability. This ought to include considerations about sustainable growth and the development of a ‘carbon bubble’ that could threaten the financial system.
What can the central banks do to ‘green’ their monetary policy?
The banks should begin to consider how their monetary policies could both affect and be affected by climate change and the transition to a low-economy. Central banks and other financial institutions are already considering the potential risks to the financial system from a transition away from high-carbon paths. They should turn this investigation towards their monetary policies too.
More transparency is needed about how banks choose which assets to purchase under QE, and from which firms to buy. The Bank of England has some objective eligibility criteria – credit rating, maturity – but they also have some more subjective criteria: namely that the companies make a ‘material contribution to economic activity in the UK’ either through employment or profits. By increasing the transparency of subjective criteria, the banks would set a good example for the private sector by mirroring the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures. Additional disclosures would also aid in external analysis of the effects of the purchase programs.
Additional analysis could also allow central banks to consider revising their purchasing strategy to account for climate change risk and financial stability implications.
A smooth transition to a low-carbon economy will require coordinated policies to scale up low-carbon finance and access to financial markets. So, central banks and other authorities should coordinate with fiscal and financial regulatory authorities to identify and address institutional barriers to low-carbon investment. For example, if a wind energy company is not eligible for purchase or to be used as collateral with the ECB, the European Investment Bank could help improve their credit rating.
Central banks should set an example for financial markets in mainstreaming considerations of climate risk
Speeches on climate change risks by Mark Carney, the Governor of the Bank of England, have prompted discussions within the financial sector. By mainstreaming considerations of climate change into their day-to-day operations, the ECB and Bank of England can now send a clear signal to financial markets that this is not a niche environmental issue, but a feature of a world undergoing a large-scale structural transformation of its economy.