Social Europe

politics, economy and employment & labour

  • Themes
    • Global cities
    • Strategic autonomy
    • War in Ukraine
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter
  • Membership

Is It Time To Take Away The Carbon Punch Bowl?

Josh Ryan-Collins 1st September 2017

Josh Ryan-Collins

Josh Ryan-Collins

Climate change poses serious financial risks. Perhaps the biggest systemic risk is a disorderly transition to a low carbon economy. As noted in the Bank of England’s ‘response to Climate Change’, current forecasts suggest that to keep global average temperatures below 2 degrees, around two-thirds of current fossil reserves must be left in the ground. Companies with carbon-intensive business models are facing large potential losses since their activities and current market value rest upon the future extraction of what is, in effect, ‘unburnable carbon’.

Banks and other financial institutions which make loans to these companies may face higher than expected default rates and non-performing loans because a large part of these companies’ future income – needed to repay loans – is dependent on the use of these ‘stranded assets’.

Although only a small percentage of banks’ loans go directly to carbon-intensive industries (such as energy companies), transition risk might also affect a range of other industries such as transport, construction as well as households, to which banks are much more exposed.

For example, environmental taxes and regulations imposed on diesel cars could have a disastrous impact on car finance companies whose leasing models are dependent on the ability to sell on second hand cars at a reasonable value.

Eco stress tests

A recent attempt to conduct a ‘climate change stress test’ on Eurozone banks found their exposures to this wider range of sectors to be similar in size to their existing capital base.


Become part of our Community of Thought Leaders


Get fresh perspectives delivered straight to your inbox. Sign up for our newsletter to receive thought-provoking opinion articles and expert analysis on the most pressing political, economic and social issues of our time. Join our community of engaged readers and be a part of the conversation.

Sign up here

Yet the main approach of central banks and financial regulators, ministries of finance and international bodies such as the Financial Stability Board to the problem of stranded assets has been to rely upon market-based solutions.

In particular, there have been major initiatives to encourage the voluntary disclosure of fossil fuel assets and exposures by both companies and financial institutions. The hope is that with better information, financial institutions will naturally adjust their investment and lending behavior away from carbon intensive activities, leading to a gradual fall in value of such assets.

Whilst better market information is to be welcomed, the financial crisis of 2007-08 made clear the danger of relying on the market and financial institutions’ ability to judge and price risk themselves.

This prompted central banks to take a new approach: ‘macroprudential policy’. This recognizes that market actors may be blind to certain forms of economy-wide systemic risk – including for example the build-up of mortgage debt and house prices relative to incomes. Regulators have a duty to step in when markets are becoming overheated and risk is not properly priced into asset prices.

In more colourful terms, central banks have a duty to ‘take away the punchbowl as the party was getting out of control’.

Credit rating agencies, equity and bond analysts typically focus on the relatively short-term, e.g. 1-5 years, and assume linear returns on investment. But climate change, as Mark Carney has noted, poses a longer term, systemic risk with potentially non-linear impacts involving very rapid price adjustments to carbon-assets.

Green macroprudence

What then might ‘green’ macroprudential policy look like? Most obviously, it might require banks to hold more capital against carbon-intensive (‘brown’) loans given the increased forward-looking risk of default.

The EU high level expert group on sustainable finance backed this idea in its recent interim report, arguing that a ‘brown-penalising’ factor would ‘yield a constellation in which risk and policy considerations go in the same direction’ (p. 32).


Support Progressive Ideas: Become a Social Europe Member!


Support independent publishing and progressive ideas by becoming a Social Europe member for less than 5 Euro per month. You can help us create more high-quality articles, podcasts and videos that challenge conventional thinking and foster a more informed and democratic society. Join us in our mission - your support makes all the difference!

Become a Social Europe Member

Other options could involve quantitative caps on debt-financing of firms heavily dependent on carbon assets in line with a below 2 degrees temperature scenario; or some form of counter-cyclical measure, whereby capital requirements would be raised if lending to carbon-intensive sectors began to increase. All these tools are currently in use by a number of central banks to guard against excessive real estate exposures.

The most common argument against interventions of this type is that it is the job of the government, not the independent central bank, to impose policies to repress or support particular sectors of the economy.

Again, however, this seems inconsistent with macroprudential policy. In the aftermath of the financial crisis, independent central banks took on responsibility for interventions in the mortgage market precisely because it was felt politicians, ministries of finance and the market itself would find it harder to ‘Take away the Punchbowl’ given political pressures. For example, in countries where the majority of voters are home-owners or would like to become so, policies that restrict mortgage credit or reduce house price growth are likely to be highly unpopular.

Before the deluge

The same issues apply to the problem of stranded assets. Politicians and ministers of finance are under enormous pressure not to regulate against large companies locked into unsustainable industries. The lobbying power of these organisations is evident in the still enormous subsidies they receive – far outweighing the subsidies flowing in to renewable energy. There is, as with house prices, also pressure from voters. The introduction of a carbon tax for example would almost certainly push up the cost of the majority of household’s energy bills.

This is not to say that governments should not also be going much further much faster to address the risks from climate change. It is rather to say that central banks have a duty to take financial stability risk seriously, whatever sector of the economy it is coming from.

No doubt designing effective green macroprudential policy will be challenging and have some unintended side effects. But many pension companies and other long-term institutional investors are already developing sophisticated green investment strategies upon which central banks and regulators could build.

Ultimately, it is surely better to have imperfect regulatory frameworks that begin to steer finance in the right direction and deflate the carbon bubble than clean up what could be a very big financial mess after the event.

Josh Ryan-Collins

Josh Ryan-Collins is a Senior Economist at the New Economics Foundation where he leads work on macroeconomics and finance. He is the lead author of two books: Where Does Money Come From? and Rethinking the Economics of Land and Housing. He has broadcast experience on the BBC, Sky News and Radio 4 and his work has featured in the Guardian and Wall Street Journal.

You are here: Home / Economy / Is It Time To Take Away The Carbon Punch Bowl?

Most Popular Posts

Russia,information war Russia is winning the information warAiste Merfeldaite
Nanterre,police Nanterre and the suburbs: the lid comes offJoseph Downing
Russia,nuclear Russia’s dangerous nuclear consensusAna Palacio
Belarus,Lithuania A tale of two countries: Belarus and LithuaniaThorvaldur Gylfason and Eduard Hochreiter
retirement,Finland,ageing,pension,reform Late retirement: possible for many, not for allKati Kuitto

Most Recent Posts

Vienna,social housing Vienna social-housing model—celebrated but misusedGabu Heindl
social democracy,nation-state Social democracy versus the nativist rightJan Zielonka
chemical,European Union Which comes first—Big Toxics’ profits or health?Vicky Cann
Russia,journalists,Ukraine,target Ukraine: journalists in Russia’s sightsKelly Bjorkland and Simon Smith
European Union,enlargement,Balkans EU enlargement—back to the futureEmilija Tudzarovska

Other Social Europe Publications

strategic autonomy Strategic autonomy
Bildschirmfoto 2023 05 08 um 21.36.25 scaled 1 RE No. 13: Failed Market Approaches to Long-Term Care
front cover Towards a social-democratic century?
Cover e1655225066994 National recovery and resilience plans
Untitled design The transatlantic relationship

Eurofound advertisement

Eurofound Talks: housing

In this episode of the Eurofound Talks podcast, Mary McCaughey speaks with Eurofound’s senior research manager, Hans Dubois, about the issues that feed into housing insecurity in Europe and the actions that need to be taken to address them. Together, they analyse findings from Eurofound’s recent Unaffordable and inadequate housing in Europe report, which presents data from Eurofound’s Living, working and COVID-19 e-survey, European Union Statistics on Income and Living Conditions and input from the Network of Eurofound Correspondents on various indicators of housing security and living conditions.


LISTEN HERE

Foundation for European Progressive Studies Advertisement

The summer issue of the Progressive Post magazine by FEPS is out!

The Special Coverage of this new edition is dedicated to the importance of biodiversity, not only as a good in itself but also for the very existence of humankind. We need a paradigm change in the mostly utilitarian relation humans have with nature.

In this issue, we also look at the hazards of unregulated artificial intelligence, explore the shortcomings of the EU's approach to migration and asylum management, and analyse the social downside of the EU's current ethnically-focused Roma policy.


DOWNLOAD HERE

Hans Böckler Stiftung Advertisement

WSI European Collective Bargaining Report 2022 / 2023

With real wages falling by 4 per cent in 2022, workers in the European Union suffered an unprecedented loss in purchasing power. The reason for this was the rapid increase in consumer prices, behind which nominal wage growth fell significantly. Meanwhile, inflation is no longer driven by energy import prices, but by domestic factors. The increased profit margins of companies are a major reason for persistent inflation. In this difficult environment, trade unions are faced with the challenge of securing real wages—and companies have the responsibility of making their contribution to returning to the path of political stability by reducing excess profits.


DOWNLOAD HERE

ETUI advertisement

The future of remote work

The 12 chapters collected in this volume provide a multidisciplinary perspective on the impact and the future trajectories of remote work, from the nexus between the location from where work is performed and how it is performed to how remote locations may affect the way work is managed and organised, as well as the applicability of existing legislation. Additional questions concern remote work’s environmental and social impact and the rapidly changing nature of the relationship between work and life.


AVAILABLE HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us

RSS Feed

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube