Central banks discover adaptation is part of the mandate

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It may have taken seven years, but at last the world’s central banks are looking at the other way to respond to climate risks besides cutting emissions.

That’s right – the Network for Greening the Financial System (NGFS) is getting into climate adaptation.*  In a Conceptual Note published last month, the group says central banks have a vested interest in amplifying efforts to protect physical assets from climate change and build “financial resilience” against its effects.

As astute NGFS-watchers know, the club has worked over the years to contextualize central bank responses to climate risks within their traditional mandates, an approach that I’ve argued has led to some pretty toothless proposals.  But I get it – this is a loose affiliation of central banks from countries with very, very different attitudes to climate change.  Perhaps the best way to motivate them is to argue that taking climate action is fully aligned with their legal mandates.

Indeed, I believe it’s an argument that’s actually more convincing when it comes to adaptation.  There is decent evidence now that climate physical risks, if left unchecked, have deleterious effects on countries’ economies – and on the macroeconomic variables that matter to central bank mandarins.  

For example, as the Note relates, studies show that climate shocks can lead to spikes in inflation.  Isabel Schnabel, Member of the Executive Board of the ECB, coined the term “climateflation” for this phenomenon, saying in a 2022 speech:

“As the number of natural disasters and severe weather events is rising, so is their impact on economic activity and prices. For example, exceptional droughts in large parts of the world have contributed to the recent sharp rise in food prices that is imposing a heavy burden on people who are struggling to make ends meet.”

And of course, climate-driven disasters like storms, floods, and wildfires can affect employment numbers.  In July this year, for instance, the number of US workers unable to work because of bad weather hit 436,000. Hurricane Beryl, a string of sweltering heatwaves, and a spate of floods and wildfires were to blame.  Sure, many of these stoppages were temporary, but there are undoubtedly long-term output effects from climate shocks – some positive, some negative – that have ramifications for central bank policy.

The Conceptual Note also cites the potential threat to financial stability posed by climate disasters.  This idea has been contested by Tony and myself, since the evidence thus far suggests financial institutions do rather well for themselves in the wake of natural catastrophes (check out Tony’s piece here which rounds up a bunch of relevant literature).  But sure – maintaining financial stability is a job for central bankers, and even potential exacerbators of credit, market, and underwriting risk are worth their attention.

So central banks can say with a straight face that part of their job is to help harden their jurisdictions against climate impacts.  It’s certainly an easier sell than arguing existing central bank mandates oblige them to actively support greenhouse-gas cutting activities, where the inflationary, employment, and broader financial risk ramifications are less certain.

The next question is: what can and should central banks do about it?  Here, I feel the NGFS paper falls short.  Sure, this is a “Conceptual Note”.  I shouldn’t expect a grand treatise.  But I still feel the ideas and proposals put forward are small beer.

These boil down to three imperatives:  encouraging better risk management practices among financial institutions, promoting insurance access and affordability, and scaling up adaptation financing.  

The first of these represents a continuation of the NGFS’ near decade-long effort to popularize climate-related financial disclosures, sustainable investment taxonomies, and climate scenario analysis.  It’s an effort that’s been largely successful, given the embrace of disclosure requirements by many financial authorities around the world and the establishment of a sustainability reporting “baseline” by global standard-setters.  Yes, more could be done to foreground adaptation in these disclosures, and the Note urges supervisors to take steps to get  adaptation topics included in companies’ transition plans, which today are mainly focused on climate mitigation.  However, I’d argue this is table stakes for financial supervisors.  Moreover, we should know by now that increased disclosure of sustainability information does not automatically lead to more climate-friendly practices.  Data alone is not enough.

The second imperative is largely outside of the gift of central banks (though some NGFS entities have oversight of insurers as well as banks), and the Note has little to say about what institutions can do directly to close insurance protection gaps.  For sure, there’s plenty on the importance of “collaboration” with government agencies and industry to address insurance affordability and to map out the transmission of risk from insurers, to banks, and the broader financial system – but no new, inventive proposal on expanding central bank and supervisory power to deal with protection gaps directly.  

What would such a proposal look like?  The estimable Nathan Tankus offers one idea for the US context:  the setting up of a “hurricane crisis facility” by the Federal Reserve that would send disaster relief funding directly to municipalities hit by natural disasters – like Asheville in North Carolina, which was battered by Hurricane Helene earlier this year.  This kind of instant liquidity would make up for gaps in insurance protection and allow affected communities to build back faster and stronger. 

As Tankus argues:

“It would be a dereliction of duty for the Fed to not get involved in making disaster-financing smoother.  Whatever concerns there would be from the demand effects of ensuring timely and sufficient disaster financing must be weighed against the supply chain and productive capacity effects of allowing recovery efforts to be slower and less sufficient.”

It’s this kind of bold thinking that’s missing from the NGFS paper.

As for the third imperative – scaling adaptation finance – again this is a laudable and important endeavor and one which the NGFS has little of value to offer.  While the Note says “central banks and supervisors can play a role in closing this finance gap”, what this amounts to is fostering an “enabling environment” through “collaboration, capacity building or the conduct of economic and financial analyses.”

*Sigh*.  As Mondale said to Hart:  Where’s the beef?

What about dedicated liquidity facilities for adaptation bonds?  Or offering financial institutions preferential cash borrowing rates in exchange for resilience loans?  How about central banks dedicating slivers of their own funds portfolios toward blended finance structures that mobilize private capital for climate-proofing purposes?  Wouldn’t these be more direct and powerful means to scale adaptation finance?

Once again, I’m back to bemoaning the toothlessness of the NGFS.

Still, despite my grousing I do still think the Conceptual Note is significant.  Not because of its content, no – but because it represents an important milestone in central bank approaches to climate change.  

Adaptation has long been the black sheep of the climate policy world.  I’ve heard from academics that for many years, researchers have fretted over the theme, apparently out of concern that if it was given too much prominence, it would be a green light to policymakers to slow down their carbon-cutting efforts.  Perhaps central banks had been hamstrung by similar concerns.

Now, at least, we can start an honest conversation about actual climate and weather impacts on economies and societies, and how central banks and supervisors could and should respond.  While this time around the NGFS lacked in boldness, by opening the discussion they are offering space for new ideas on the use of central bank power.  That’s certainly something to welcome.  

*Ok, ok, to be fair they came out with a paper on scaling climate mitigation and adaptation finance in last 2023 – but that did not go deep on central banks’ role promoting adaptation directly