On the toothlessness of the NGFS

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Central banks have great powers and great responsibilities. I wonder if they don’t forget both when it comes to climate change.

Recent developments out of the Network for Greening the Financial System (NGFS), the club of climate-focused central banks and supervisors, make my case. On Thursday, the network put out a guide on how central banks can use their own funds portfolios to align with sustainable and responsible investment practices.  What’s important to recognize here is that central banks’ own funds portfolios are their smallest, and therefore least impactful, collection of assets.  For example, the European Central Bank’s own funds portfolio was €22.1bn at end-2023, out of a total balance sheet of €6.9trn.

Now the NGFS paper says “central banks can lead by example” by factoring climate into their investment decisions, which could mean excluding dirty, carbon-intensive investments from their books and favoring green bonds and similar climate-friendly investments instead.

The thing is, I doubt central banks are idolized as investors par excellence.  When was the last time you heard a fund say they wished they could emulate the performance of the Banque de France?  As public institutions, they are bound by conventions and risk controls that put capital preservation above risk taking – unlike a good deal of private financial market participants.

If all central banks piled their own funds portfolios into green bonds and shunned fossil fuel assets, for sure this would be a strong moral signal, but I wonder whether it’d produce a meaningful price signal.  Bloomberg says private banks extended $527bn of fossil fuel debt in 2023.  Central bank’s own fund investments in this area are just a drop in the ocean.

Which all leads me to wonder why the NGFS is producing guidance around the weakest channel through which central banks can have climate impact.  We all know that central banks have vast power to shape financial markets through their monetary policy and quantitative easing (QE) portfolios, which are used to set short-term rates and cushion financial markets in times of crisis, respectively.  Where’s the original thinking on using these tools to drive climate impact?  Part of the NGFS’ mission is “to mobilize mainstream finance to support the transition toward a sustainable economy”, after all.

Now to be fair, the network did put out the results of a survey last July on climate change and monetary policy.  This showed that 60% of respondents believed they had the freedom to adjust their operational frameworks to integrate climate issues.  It also put out papers in 2020 and 2021 on monetary policy.  However, these were very much analysis pieces, which surveyed current practices rather than setting out novel ideas through which central banks could bend their huge powers toward the good of the climate.

Yes, I get that the NGFS has to tread carefully.  It’s a voluntary network of over 100 institutions, and keeping them all sweet can’t be easy. True, the ECB – a climate hawk – is a prominent member, but so are the central banks of Saudi Arabia, Abu Dhabi, and Russia are too, not to mention the monetary authority of the world’s largest oil producer – the US.

Still, what’s the point of a network set up to support a low-carbon transition if it’s not going to be a forum for bold ideas?  If the network is voluntary anyway, what’s the harm in producing research on some of the more “out there” polices central banks could pursue?

Instead of the NGFS being in the vanguard of central bank climate policies, politicians are taking the lead. Last month, President Macron of France called for a debate on making the climate transition a more explicit part of the ECB’s mandate: “We need a theoretical and political debate on how to integrate a growth objective into the objectives of the European Central Bank, or even a decarbonisation objective – in any case, a climate objective for our economies. It is absolutely essential,” he said. This followed on from comments he made in December favoring the use of differential interest rates to finance green and carbon-intensive projects, something that could be facilitated by the ECB’s bond-buying.

The NGFS, as a network, didn’t respond, but notably Francois Villeroy de Galhau, head of the Banque de France which hosts its secretariat, said it was an “illusion” that central banks could engage in green QE in this way, claiming legal barriers and inflationary concerns. “We need to resist the magic wand temptation,” he said.

I’d take his criticism more seriously if his preferred means of achieving a low-carbon transition wasn’t a global carbon price, a stubborn fantasy that simply won’t pass muster in much of the world.  And, as Macron’s interventions suggest, there is appetite to remove legal barriers in the EU.  Furthermore, some central banks have waved the magic wand already – for example, the Bank of Japan launched a program in 2022 providing zero-interest loans to renewable energy projects (though admittedly this made up only a tiny fraction of its overall portfolio).

Given all this, what’s the point of the NGFS and its member banks being so cautious and conservative just talking about the climate powers they could unleash?  The network has the ability to move the Overton Window by presenting ideas and producing research that could convince politicians to give them the freedom they need to be more effective climate champions.  

Ironically, by holding back, central banks could see their destinies taken out of their hands – as the Macron interventions indicate.

But instead of being bold, what’s next on the NGFS’ docket? Responsible Investor says it’s a body of work on investment stewardship guidance for central banks, in response to members’ increased desire to “steer real world outcomes.”

C’mon.  If central banks want to steer real world outcomes, it won’t be through their piddling investment portfolios.  It’ll be by exerting the might of their monetary policy and QE powers.  Please NGFS, focus on where you can have the most impact, and stop fiddling around the edges.