Climate-neutral central banking: How the European system of central banks can support the transition to net-zero

Published on May 23, 2021
Simon Dikau, Nick Robins, Ulrich Volz

This policy report sets out why central banks in the EU need to adopt net-zero strategies, and provides seven concrete recommendations for how they can. The report builds on the global framework set out in the authors’ recent publication Net-zero central banking: A new phase in greening the financial system, and applies its approach to the specific priorities and mandates of EU central banks.

Main messages
  • Climate neutrality is a key pillar of the European Union’s Green Deal programme, together with strengthening resilience to physical shocks and ensuring that the transition process is fair and just.
  • The first signs that EU central banks are recognising the imperative of alignment with net-zero are beginning to emerge. A comprehensive approach is now required, not least as part of the European Central Bank’s strategy review.
  • To make this happen, the European System of Central Banks (ESCB), with the ECB at its helm, needs to mainstream net-zero across all ESCB operations.
  • There is a compelling two-fold rationale for doing this: first, net-zero is the best way of minimising the risks of climate change to the stability of the EU economy and financial system; and second, EU central banks and supervisors need to ensure that their activities are coherent with the EU’s and member states’ climate neutrality policies.
Recommendations for upgrading EU central bank and supervisor approaches in line with climate neutrality
  1. Strategy: EU central banks and supervisors need to develop a climate neutrality roadmap, with long-term expectations and near-term actions. This would include the promotion of close liaison between policymakers and central banks. The mission statement of the ECB should be updated to include the EU’s climate neutrality objective as part of this.
  2. Prudential regulation: Prudential supervisors in the EU should make climate neutrality a core element of supervisory practice at micro and macro levels, aligning supervisory expectations and prudential instruments with net-zero. This would involve requiring all regulated financial institutions to submit net-zero transition plans. Prudential capital requirements should also reflect financial institutions’ exposure to climate risks.
  3. Scenarios: Forward-looking scenarios used by EU central banks and supervisors need to become more consistent with a climate neutrality pathway to limiting warming to 1.5°C and complemented with short-term outlooks.
  4. Monetary policy: The ESCB needs to consistently integrate climate neutrality into monetary frameworks and models to adequately account for the impacts of climate change on macroeconomic outcomes. In addition, central bank instruments and policy portfolios need to become operationally aligned with net-zero.
  5. Portfolio management: Sustainable and responsible investment practices in all European central bank portfolios should include a climate neutrality target, and central banks should each publish a transition plan to achieve this.
  6. Just transition: EU central banks should assess the implications of net-zero for jobs and livelihoods and explore policy options to mitigate potential downside sectoral and regional consequences.
  7. International cooperation: Climate neutrality needs to be incorporated into the way that EU central banks operate within key international financial and regulatory frameworks and processes. The EU’s central banks have the potential to be global leaders in climate-neutral central banking.

Produced with the Centre for Sustainable Finance at SOAS, University of London.