THE TIGHTENING LINKS BETWEEN FINANCIAL SYSTEMS AND THE LOW-CARBON TRANSITION

Transcription

1 THE TIGHTENING LINKS BETWEEN FINANCIAL SYSTEMS AND THE LOW-CARBON TRANSITION Emanuele Campiglio - Vienna University of Economics and Business Antoine Godin - Kingston University Eric Kemp-Benedict - Stockholm Environment Institute Sini Matikainen - London School of Economics and Political Science Cambridge March 30 th, 2017 Cambridge Trust for New Thinking in Economics

2 Introduction The effect of the Global Financial Crisis (GFC) on the prospect of a low-carbon transition Focus on GFC-induced policies and their effects on the transition The immediate effects have been moderately negative: Decrease in public spending and fiscal support New macroprudential regulation discouraged bank lending to lowcarbon projects Monetary policies perpetuated the high-carbon lock-in of the system However, new space for concept development and policy proposals: Green growth and the push for carbon pricing Climate-aligned macroprudential regulation Green quantitative easing (green bonds)

3 The low-carbon transition trade-off Source: Campiglio et al. (2017) A slow transition would lead to high climate-induced costs (physical damages, economic loss, financial instability) A too rapid transition would lead to high adjustment costs (sectoral economic losses, financial instability) Need to find a balance between these two extremes

4 THE EFFECT OF GFC-INDUCED POLICIES ON THE TRANSITION Spending and taxation Macroprudential regulation Unconventional monetary policies

5 Fiscal policy (I) At first, counter-cyclical stimulus packages Green New Deal: use the occasion to give a boost to the green economy But soon after: austerity Fiscal policy directed towards achieving balance budgets Reduction of public expenditure Source: Barbier (2010)

6 Fiscal policy (II) In theory, austerity strategies can have a range of different effects for the transition: 1. Reduction of public spending Negative: reduction or elimination of sustainable infrastructure development 2. Reduction of fiscal support Negative if it s subsidies to low-carbon technologies being cut Positive if it s fossil fuel subsidies 3. Increase in the tax burden Positive if it involves the introduction or expansion of environmental taxation (e.g. carbon tax)

7 Fiscal policy (III) What actually happened? 1. Reduction in public spending and investment 2. Reduction of feed-in tariffs for renewable energy In some cases retroactively 3. No reduction of fossil fuels subsidies But main subsidisers only marginally hit by crisis 4. No generalized introduction of environmental taxation With exceptions: Ireland, Iceland, France and others

8 Carbon taxation around the world Source: PMR 2017

9 A shifting narrative More generally, public discourse shifted towards shortterm economic issues Long-term environmental considerations considered as postponable luxuries..the repeal of the carbon tax means a $550 a year benefit for the average family Tony Abbott Former PM of Australia On energy, I will cancel jobkilling restrictions on the production of American energy including shale energy and clean coal creating many millions of high-paying jobs Donald Trump President of the United States Source: Wikiquote

10 Macroprudential regulation (I) Basel III regulation Source: BCBS

11 The environmental effects of macropru Basel III could be negatively affecting bank lending towards low-carbon sectors In particular, renewable energy projects A higher degree of risk is associated with long-maturity project finance, Risk-weighted capital ratios worsen But: default rate of rated project finance debt is lower than the one for corporate issuers Project finance debt not classified as high-quality liquid asset by LCR Loans to renewable energy have longer tenors compared to gas/coal plants This is due to high initial capital costs Banks have to match long-term assets with stable funding for a longer period This may lead banks to reduce the tenor of the loan (refinancing risk) In general, Basel III could push lending towards liquid, short-term, risk-free assets Renewable projects are illiquid, long-term investments, with a range of attached risks However, still unclear how relevant this effect is Banks seem to be coping well with capital and liquidity requirements Survey by CISL (2014): Basel III requirements a marginal factor in lending decisions

12 Monetary policy Cut in interest rates Expansion of balance sheets (Quantitative Easing) Mainly sovereign bonds, but also covered bonds, asset-backed securities, corporate bonds (ECB and BoE), equities (Japan) Source: BIS 2016

13 The environmental implications of QE Some QE programmes started purchasing private securities European Central Bank: Corporate Sector Purchase Programme (CSPP) Bank of England: Corporate Bond Purchase Scheme (CBPS) In principle, purchases aim to be neutral BoE respects certain sectoral shares of eligible bonds ECB focus on rating In practice, they are likely to show an institutional or sectoral bias, although unintentional Even using relative market size as benchmark may reflect existing market distortions More generally, purchases are likely to create a spread in financing conditions between firms Source: Keohane 2016, FT Alphaville

14 ECB CSPP programme 18% 16% Manufacturing* 14% 12% Real estate activities Percentage of GVA 10% 8% 6% Wholesale and retail trade Financial and insurance activities Transportation and storage 4% Administrative Information and communication Electricity, gas, steam and air conditioning supply 2% Chemicals and chemical products Refined petroleum and coke production 0% 0% 5% 10% 15% 20% 25% 30% 35% Estimated percentage of purchases Size of bubble indicates relative contribution to emissions in the Eurozone Source: Campiglio et al. (2017)

15 Bank of England CBPS programme 16% 14% 12% Real estate activities Percentage of GVA 10% 8% 6% 4% Education Health and social work Wholesale and retail trade Information and communication Transportation and storage Manufacturing* Electricity, gas, steam and air conditioning supply 2% Mining and quarrying Water supply Manufacture of petroleum 0% 0% 5% 10% 15% 20% 25% 30% 35% Estimated purchases Size of bubble indicates relative contribution to emissions in the UK Source: Campiglio et al. (2017)

16 NEW CONCEPTS AND POLICY PROPOSALS Green growth Climate-aligned macroprudential regulation Green quantitative easing

17 Green growth At first: Sustainable Development (SD) But: narrative too focused on sacrifices and costs Post-GFC: looking for a positive, economy-friendly narrative Green growth No need to choose between environmental sustainability and economic prosperity Grow through the expansion of green sectors All major international institutions support it

18 Green growth (II) Policy intervention required Market failures to be corrected Main tool: carbon pricing Revenue recycling and the double dividend from carbon taxation However, is it realistic? Governments fiscal action paralysed by austerity strategies Sluggish growth suggests to avoid further taxation Even in normal times, will the effort ever be strong enough? Required decarbonisation rate much higher than ever experienced (Antal and van Den Bergh, 2015; PwC, 2015) Additional market failures in credit markets (Campiglio, 2016)

19 Climate-aligned macropru (I) Align macroprudential regulation to climate objectives Climate-related financial risks acknowledged by central banks and financial regulators Rationale: climate-related financial risks (Carney 2015): Physical risks (Dietz et al., 2016) Liability risks Transition risks Transition risks: stranded assets Fossil fuel reserves Stocks of high-carbon physical capital Stranded financial assets and potential cascade effects Battiston et al. (2016)

20 Climate-aligned macropru (II) Differentiated reserve requirements Decrease reserve requirement ratios for banks that lend to lowcarbon activities (Rozenberg et al. 2013) The Lebanese experience However, unlikely to work in high-income countries where central banks mainly want to fix interbank rate (Campiglio, 2016) Differentiated capital requirements Different capital adequacy ratios according to the type of lending they provide Green risk weighting for capital requirements ESG considerations in risk formulation?

21 Green Quantitative Easing (I) Central banks are purchasing large amount of assets Direct the purchase towards low-carbon assets (green bonds)? Green bonds can be issued by governments, companies and development banks Purchase of green bonds issued by development banks ECB is already purchasing bonds from supranational entities (e.g. European Investment Bank) The precedent of Canada s Industrial Development Bank (Ryan- Collins, 2013) Development banks bonds tend to have good ratings and are able to lend at lower cost Constraints put on development banks Leverage ratios and conservative capital management No autonomous balance sheet expansion

22 Green Quantitative Easing (II) Reluctance of central banks to target specific sectors Shape of the economic system responsibility of elected governments Too many eggs in their basket However: many examples of targeted intervention TLTRO by the ECB (excluded financial sectors and lending for house purchase) Funding for Lending Scheme in the UK (SMEs) Bangladesh and emerging economies (Monnin and Barkawi, 2015) And even when not explicitly targeted, sectoral effects are likely (Krishnamurthy, A. and Vissing-Jorgensen, 2011)

23 CONCLUSIONS

24 Conclusions Finance-climate risks increasingly relevant Need to finance the transition to a low-carbon economy Climate-related transition financial risks The effects of the GFC: 1. Moderately negative direct effects Postponement of public spending and reduction of green fiscal support GFC-induced financial regulation reduced incentives for low-carbon lending Unconventional monetary policy perpetuated the high-carbon status-quo 2. Potential positive longer-term effects New concept development and policy proposals Green growth as a growth-friendly version of Sustainable Development Include climate risks into macroprudential regulation Use expanded powers of central banks to finance sustainable investment

25 THANKS! Emanuele Campiglio Vienna University of Economics and Business

26 Bibliography Antal, Miklós, and Jeroen CJM Van Den Bergh Green Growth and Climate Change: Conceptual and Empirical Considerations. Climate Policy 16 (2): Barbier, Edward How Is the Global Green New Deal Going? Nature 464 (7290): Battiston, Stefano, Antoine Mandel, Irene Monasterolo, Franziska Schütze, and Gabriele Visentin A Climate Stress-Test of the Financial System. Nature Climate Change, March. doi: /nclimate3255. Campiglio, Emanuele Beyond Carbon Pricing: The Role of Banking and Monetary Policy in Financing the Transition to a Low-Carbon Economy. Ecological Economics 121: Campiglio, Emanuele, Sini Matikainen, and Dimitri Zenghelis Climate-Related Risks and Financial Stability: The Impact of Quantitative Easing. Forthcoming. Policy Paper. London: Grantham Research Institute on Climate Change and the Environment. Carbon Tracker Unburnable Carbon 2013: Wasted Capital and Stranded Assets. London: Carbon Tracker Initiative and the Grantham Research Institute. Carney, Mark Breaking the Tragedy of the Horizon climate Change and Financial Stability. Speech given at Lloyd s of London by the Governor of the Bank of England 29 (September) Resolving the Climate Paradox. CISL Stability and Sustainability in Banking Reform: Are Environmental Risks Missing in Basel III? Cambridge: University of Cambridge Institute for Sustainability leadership. Dietz, Simon, Alex Bowen, Charlie Dixon, and Philip Gradwell Climate Value at Risk of Global Financial Assets. Nature Climate Change 6: FS-UNEP, and BNEF Global Trends in Renewable Energy Investment Frankfurt School- UNEP Centre and Bloomberg New Energy Finance. Godin, Antoine, Emanuele Campiglio, Elena Dawkins, and Eric Kemp-Benedict Climate Financial Bubbles: How Market Sentiments Shape the Transition to Low-Carbon Capital. Mimeo. Krishnamurthy, Arvind, and Annette Vissing-Jorgensen The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy. Working Paper National Bureau of Economic Research. PMR Carbon Tax Guide: A Handbook for Policy Makers. Washington, DC: Partnership for Market Readiness, World Bank. Rozenberg, Julie, Stéphane Hallegatte, Baptiste Perrissin-Fabert, and Jean-Charles Hourcade Funding Low-Carbon Investments in the Absence of a Carbon Tax. Climate Policy 13 (1): Ryan-Collins, Josh, Richard Werner, Tony Greenham, and Giovanni Bernardo Strategic Quantitative Easing: Stimulating Investment to Rebalance the Economy. Report. New Economics

27 The investment financing process Source: Campiglio et al. (2017) Financing the transition requires support in each stage of the process