The Bank of England is right to remain committed to tackling climate risk

Climate change isn’t a distraction to financial regulators – it is a looming threat that needs to be averted, argues James Fotherby, Senior Policy Officer at the Aldersgate Group.

In a recent article, former Bank of England governor Lord King became the latest to argue that the Bank’s growing remit – including climate change – serves as a distraction from its dual mandate of price and financial stability.

But, the Bank is right to remain committed to addressing the impacts of climate change. Not only does it pose a serious threat to financial stability in the long-term but it is driving inflation in the present.

Rather than scrap financial regulator’s remit on climate change, the government should strengthen it – enabling regulators to go further in mitigating climate-related risks.

Ignore climate change at your peril

In 2015, Lord King’s successor Mark Carney warned us of the tragedy of the horizon. This is where long-term climate-related risks are overlooked in narrow electoral, business, and monetary policy cycles. This short-termism allows climate risks to build-up, meaning, “once climate change becomes a defining issue for financial stability, it may already be too late”.

Failure to address future climate risks could leave the financial system vulnerable to shocks. Catastrophic weather events will impact the value of financial assets, affecting households and businesses, meanwhile a rushed transition to low-carbon energy could leave financial institutions exposed to large losses due to the risk of stranded fossil fuel assets. Clearly, minimising these risks by facilitating an early and orderly transition is in the interests of the Bank.

This is not to say, though, that climate change does not pose a serious threat to price stability in the present. The European Central Bank estimates that climate change will raise global inflation by as much as one per cent every year as food prices are impacted by extreme weather. This can be seen in the latest ONS inflation figures as sugar and olive oil, the two top inflating food items, have increased by 54 per cent and 41 per cent respectively over the past 12 months. Let’s not forget, also, that today’s inflation is largely fossil-fuelled, driven by the UK’s reliance on volatile oil and gas markets.

Enable financial regulators to facilitate the transition

In his interview, Lord King stated that the “Bank of England can do nothing about climate change”, yet the focus on it has drawn attention away from monetary policy. This is simply not the case.

The Bank – and other financial regulators – have a crucial role to play in delivering net zero, both in helping financial firms to reduce their exposure to climate risk and supporting the government’s net zero commitments using their monetary, prudential, and market regulatory tools.

Quietly, in the background, regulators have begun making modest progress on both fronts. In 2021, the Bank introduced a green corporate bond purchase scheme to tilt purchases towards firms with stronger environmental records. The year after, the Bank published the results of its first ever climate stress test, which suggested that the physical effects of climate change and the net zero transition – especially in late or no additional action scenarios – could affect the vulnerability of banks and insurers to shocks, and the stability of the wider financial system. The FCA has also been busy, introducing new reporting requirements on large corporates to disclose their climate risks and climate transition plans in a bid to improve climate-related financial information.

Despite these changes, central banks and financial regulators need to go further still to embed climate change more fully within their policy work. The government must provide regulators with a stronger legal mandate to advance the UK’s climate goals when carrying out its duties. This would enable them to more proactively use their tools to prevent the build-up of climate risks and facilitate the shift of financial flows towards the low-carbon economy – for example, by setting preferential interest rates for low-carbon investments or requiring larger capital buffers on high-carbon ones.

Climate change isn’t a distraction to financial regulators; it’s a looming threat that needs to be averted. As such, it falls squarely within the mandate of the Bank and it is fundamental to its success.