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Financial markets not only have an important role to play in steering financial capital to support the net-zero transition but also are increasingly vulnerable to climate-related financial risk that may be a source of financial instability. In this context, Frank Elderson, chair of the Network for Greening the Financial System, in a speech of 2018 meaningfully titled ‘Let’s dance’, highlighted the elevated responsibility of central banks to act on climate change.

Analysing the institutional relations between political authorities (governments) and delegated authorities (central banks and financial regulators), as well as their mandates and degree of freedom for intervention across jurisdictions, the authors of this paper argue that central banks cannot and should not ‘dance alone’, as only coordinated efforts between these institutions will be sufficient to mitigate climate risks – put simply, it takes two to dance.

Supporting the analysis and to better explain the heterogeneity in institutional behaviours in the field of climate-related financial policies, the authors propose a framework to distinguish: i) the motives for policy implementation – either the desire to tackle climate change by directly influencing the allocation of financial capital (promotional) or the desire to ensure the stability of the financial system in the face of climate-related challenges (prudential); ii) the relevant policy instruments to achieve these objectives (informational, incentive and coercive); and iii) the type of implementing authority (political or delegated).

Applying this framework, the authors demonstrate how sustainable financial interventions in certain jurisdictions – most notably, the EU – rely solely on informational policies to achieve both promotional and prudential objectives; this is in contrast to emerging economies. The authors term this restricted usage of climate-related financial policies for promotional purposes in Europe a ‘promotional gap’ and explain this through two main institutional dimensions: the low strength of public control on private financial markets; and the high degree of independence of delegated authorities. This leads to an institutional deadlock in which only measures fitting with both political and delegated authorities’ objectives can be implemented.

Relying on a game-theoretic framework, the authors then argue that the current institutional setting is unstable and discuss three potential evolutions: a drift towards a green financial technocracy; a re-politicisation of delegated authorities; or a move towards fiscal-monetary coordination.

Key points for decision-makers

  • The authors provide a consistent framework to categorise climate-related financial policies.
  • The current institutional setting in Europe and similar jurisdictions only allows for informational measures, to achieve both prudential and promotional purposes.
  • This ‘promotional gap’ is explained through two main institutional characteristics: a weaker public control on private financial dynamics; and stronger and more independent delegated authorities. These traits limit the European green finance policy space to consensual informational policies.
  • The current status quo is unsustainable due to environmental constraints. At some point the introduction of stronger promotional policies to steer credit towards sustainable sectors is warranted. This will create institutional frictions concerning the distribution of power, responsibility and legitimacy. 

Authors: Moritz Baer, University of Oxford; Emanuele Campiglio, University of Bologna and RFF-CMCC European Institute on Economics and the Environment; Jérôme Deyris, University Paris Nanterre

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