Time to Charge the Real Cost for Polluting

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Switzerland Central Banks Basel Rules

COP26 was a cop-out. Although we saw progress with deals on methane reductions, on halting deforestation, on corporates’ commitment to net zero and disclosure, and the speed of the electric vehicle transition, leaders failed to commit to more ambitious national net-zero targets, and delayed actions and commitments for another year. This dismal delay draws climate tipping points closer, as we use up our carbon budget and risk smashing through the 1.5°C temperature increase goal that the world’s scientists tell us is essential to limit damage to the planet and our economies. So, what is to be done since the world cannot wait for politicians to grow spines and catch up with climate realities? The world’s central bank supervisors and regulators have room to act and speed the rate of the green transition. It’s time for polluting investments to pay the real cost of the damage they inflict on the climate and the planet.  

Drawn together in the Network for the Greening of the Financial System, the world’s most powerful central bankers agree climate change risk management is squarely within their mandates, and their modeling gives a stark warning of rising carbon costs or terrible climate outcomes. Given these conclusions, the same central banking community, meeting as members of the Basel Committee on Banking Supervision (BCBS), should be more ambitious and use the most effective supervisory tool in their arsenal — capital charges — to change banking and investment incentives away from fossil fuel projects and toward renewables and the green transition.

The BCBS should agree a “one-for-one” charge for new fossil fuel lending as demanded by a coalition of investors, academics and civil society groups. Such a rule would oblige banks and insurers to match each dollar used to finance, insure or invest in new fossil fuel ventures with a dollar of liable funds on their balance sheet. This will ensure there is an adequate capital buffer to cover the risk.

Placing a 100% charge on lending would dramatically alter the internal risk assessments and strategies of banks. Applying a one-for-one capital charge would make banks pay a higher price to pollute now and tomorrow for narrow-minded, self-interested short-term gains. One-for-one would begin to align bank capital regulation with the urgency of action we require.

To paraphrase the UN secretary-general at COP26: We need to stop digging our own graves in search of more fossil fuels. As the International Energy Agency, and recent research in Nature demonstrates, most fossil fuels need to remain in the ground if the world is to have any chance of avoiding a series of climate tipping points from which there will be no return.

One-for-one would have costs — for the polluters and in the short term, energy price hikes. A speedy halt to new fossil fuel lending would also redirect a vast flow of investment into renewables and alternative green investments. This will have significant multiplier effects, create skilled jobs, speed required technological shifts, steepen rates of adoption, further cut renewables’ prices, and spur ongoing cycles of innovation. Altering banks’ capital calculations would thus amplify the rate of change and create new economic opportunities.

Outstanding Loans

What of existing fossil fuel lending portfolios already held by banks? These loans, too, should be reassessed according to carbon intensity and be subject to a sliding scale of increasing capital charges. This would further support adjustment and realignment of bank portfolios, write-downs, and recognition that many projects (such as coal and tar sands lending) may prove to be nonperforming stranded assets in the medium term.

Moody's estimates that banks, insurers and asset managers across the G20 hold $22 trillion in loans and investments in the oil, gas and coal sectors, equivalent to roughly 20% of their total loans and investments. This is a lot of risk to swallow, but it is far better to begin risk reassessment and planning now rather than delay and face much worse crises 10 years from now.

Most banks could absorb losses over the three decades up to 2050 and reach our net-zero goal. Those banks that are extremely exposed to fossil fuel risks may need additional supervisory interventions. In extremis, national regulators should be prepared to respond with “bad bank” structures to take toxic assets off the banks’ books and wind them down. Regulators have done this before, and they need to prepare for it again.

Bank lobbyists will say, the costs are too high, the process too difficult, the issues too complex. Not so. The cost of inaction is the real and present planetary danger. Tipping points loom. The Arctic summer sea ice is disappearing. Alpine glaciers are thinning. The Gulf Stream is slowing down and could stall. The Greenland ice sheet is melting at an accelerating rate. Amazon rainforest dieback may occur. The Thwaites Glacier, known as the Doomsday Glacier of West Antarctic, is at risk of collapse. These and many other interlinked nonlinear tipping points to an unlivable hot house future are the real fat tail risks Marty Weitzman warned us we face.

In comparison to such threats, applying a one-for-one capital regime that establishes an agreed taxonomy and rule book is a simple manageable matter, as well as an urgent necessity. The technocrats meeting in Basel can do it. They are currently consulting on principles for the effective management and supervision of climate-related financial risks. Now is the time to include tier one capital changes to address rising planetary dangers. They have already done it for risky cryptocurrency loans. Central bankers and supervisors need to act now to shift expectations and market and business incentives and align capital rules with our planet’s, and human and nonhuman sustainability and survivability.

Stuart P. M. Mackintosh is executive director of the G30, and author of Climate Crisis Economics.

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