Money and Climate Change Risks: Expectations Management

Tackling climate change is one of the most important priorities of our time. There is now a broad consensus that climate change is happening, it can be extremely costly and human activity is responsible. The need for economic growth has long ignored the idea of ​​sustainability. Raised by a few, the fight against climate change has become the cause of the vast majority.

But it is one thing to acknowledge the need for consistency of policy and quite another to implement them (Weather de Mauro 2021). ‘Greening the economy’, i.e. reducing CO2 emissions in response to the ‘physical risk’ of massive climate-induced damage, will call for a larger redistribution of resources – emissions-intensive (‘brown’) to emission-light (‘green’) activities. This relocation is bound to be painful, difficult to engineer, and fraught with ‘risk of change’. This requires major government intervention (e.g. Pisu et al. 2022).

What is the role of the financial sector in this necessarily concerted effort? It is sometimes argued that the financial sector can move Compensation For inactivity in the real economy. That is, it is expected to lead the way beyond a mere supporting role for the financial sector.

Our view is that these expectations are exaggerated. Money faces all the obstacles that hinder progress in the real economy. Moreover, seeking to address these barriers first or only through the financial sector carries the risk of isolating the sector from the real economy, thereby increasing the risk of financial instability. There are risks involved Commission That would come on top of its well-known risks ExcludedThat is, those who have failed to anticipate the disruption that will result from greening the economy

The nature of the problem

Why is climate change proving so difficult?

For starters, there has been a problem Information. For a long time, a major stumbling block was the failure to agree that a problem existed in the first place. Initially, there was skepticism as to whether global warming was significant enough to indicate a trend. Later, once it is no longer debated, there is a sharp disagreement over whether human activity is primarily responsible. But now policymakers have come to the conclusion that urgent action is needed, in response to frozen evidence and the inflated public opinion led by the younger generation. Hence the recent commitment of many countries to achieve Net Zero CO2 Emissions by 2050 (UNEP 2021).

The rest, and much more, has to do with stumbling Motivation. For one, although the benefits of a transition will mainly accrue to those still born or very young and voiceless, the costs will mostly fall on those who can work now. This intergenerational conflict will diminish over time but is still much more with us. In addition, while everyone agrees on the need to work ethically, it is tempting to free-ride on the actions of others, avoiding the cost of conversion. Moreover, these costs will spread very unevenly. Among countries, the poorest segments of the population may suffer the most, for example from the high cost of polluting energy. After all, some countries may lose more than others depending on the transformation risk arising from the economic structure (e.g., emissions-intensive energy input importers or exporters) as well as the exposure to physical risk.

Government authorities have not been able to overcome these provocative problems. Problems with distribution within and between generations have hampered the necessary action Real The direction of the economy, where physical risk originates and where redistribution should occur. In principle, a well-calibrated set of taxes and subsidies (such as a carbon tax) as well as quantitative and other regulatory limits could change the engineer. But the measures and commitments taken so far fall short of what is needed (IEA 2021).

In the financial sector Options To take action and possibly lead to the real side? The problem is financial sector agents The same incentive problems are encountered as in the real sector of the economy. In the absence of the necessary changes in the real sector, agents must leave risk-adjusted returns on the table (Fisher-Vanden and Thorburn 2008). If they don’t, there will be no market failure on the path to green change in the first place. There is no free lunch.

Without effective government action,1 ‘Green choices’ may go some way to simplifying this puzzle, as they weaken personal incentives to maximize risk-adjusted returns. Hence the increase in ‘green investment’ (Aramonte and Zabai 2021, Flammer 2021).

But the mere existence of such a choice is not enough to reduce the problem. They must be large and strong enough to make a material and lasting difference in cost and funding availability. And they should be universal. Otherwise, some green choices in the financial sector will provoke arbitrary power or dubious, perhaps even fraudulent, practice by others, denying benefits.

An example of such a practice is greenwashing, an attempt to misrepresent CO2 Intensity of project or activity emissions to get cheaper funding or to market the final product more effectively. As the priority of green resources increases, so does the impetus for greenwash. Allegations of such instances have already led to several investigations (Fletcher and Oliver 2022, Economist 2021) and nationally and internationally (NGFS 2022) policy initiatives designed to improve publishing and application.

More generally, the evidence suggests that so far financial markets have made little contribution to driving the economy towards sustainability (Elmalt et al. 2021). For example, the premium at which the debt instrument is traded increases slightly with the issuer’s CO.2 Emissions (Scatigna et al. 2021). More generally, “[even though] There is some evidence [that green finance has had an] Impact on stock prices, bank loan terms, and bank credit flows, [there is] There is no irresistible evidence that the needle is moving “(Weather de Mauro 2021).

Risk of financial stability

There is a consensus that the transition increases the risk of its own financial stability (BCBS 2020, Bolton et al. 2021). But that analysis was not extensive enough.

Fundamentally, financial instability occurs when the financial and real sectors are out of coordination, as exemplified by the financial boom-bust event. Behind financial expansion, aggressive risk taking, fuel economic activity and excess balance sheets. In the process, the value of assets and the amount of debt gradually diverts from the capacity of the actual economy to create the corresponding cash flow. Since this disconnection is not inherently sustainable, the process sometimes reverses, usually abruptly and violently.

In light of this, the risk of financial stability associated with the transition Two-way. One aspect that has attracted attention so far is the exposure to overvalued ‘brown’ assets, which will lose their value as they change (become ‘unsustainable’). The concern here is that investors either fall asleep in the ‘brown vortex’ or act in a hurry, creating erratic ‘brown runs’ (e.g. Delis et al. 2018). However, there is another aspect that has received much less attention and is more in line with the familiar boom-bust pattern. This is either related to the exposure of overvalued ‘green’ assets or what we call assets – a ‘green bubble’, abbreviated (Karstens 2021, Aramente and Jabai 2021, Kochran 2021, Tate and Mundi 2022). The first aspect reflects one UnderEstimation of the scope and speed of relocation; The second one OverGuess

A green bubble is a risk factor. In principle, private investors and lenders generally have a clear incentive to run the bubble, which is tempted by self-reinforced returns. In some cases, policy and social pressures increase the risk. As government measures in the real economy still fall short of CO2 commitments, the public sector has strongly encouraged green investment. As a result, it is likely that private agents will expect public support if something goes wrong – a kind of ‘government put’. Social pressures, in turn, can strengthen imitation, or animal husbandry, further increasing the demand for green resources, even when the bubble is recognized as such. Bursting a green bubble will not only directly carry social costs but can also undermine the credibility of the change process.


The primary role of the private financial market is to reflect the underlying state of the real economy. So, it would be unrealistic to expect them to induce a green transformation until the right signal comes from the real economy. Unrealistic expectations can set the financial sector up for failure and derail change. As a key channel for asset redistribution, the financial sector must play an essential supporting role and it must avoid the risk of change.

Author’s Note: The views expressed are those of the authors, not necessarily those of the Bank for International Settlements.


Aramonte, S and A Zabai (2021), “Sustainable Financing: Trends, Evaluation and Exposure”, BIS Quarterly ReviewSeptember, pages 4-5.

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Bolton, P., M. Kakparsic, H. Hong and X. Vives (2021), The resilience of the financial system to natural disastersThe Future of Banking 3, CEPR Press.

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UNEP – United Nations Environment Program (2021), Emission Interval Report 2021: The heat is on – the world of climate promise has not yet been delivered26 October.

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1 Taxes on specific industry financing and direct provision of subsidies or financing may alter risk-adjusted returns sufficient to align individual incentives with the objective of sustainability. Of course, as experience suggests, such interventions are not straightforward to calibrate, and interventions may be ineffective if they do not agree with the clear signals from the real economy that any kind of production needs to be stimulated or punished.

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