Top economic and regulatory officials at the Basel, Switzerland Bank for International Settlements emphasized the limits of the financial industry’s ability to reduce climate risk in a new article this week, calling it “unrealistic” to assume that the financial sector could drive the reallocation of resources needed to transition to a global green economy “in the absence of adequate environmental policymaking in the real economy.”
Without a robust policy framework, “the green preferences of some in the financial sector would stimulate arbitrage forces or dubious, possibly even fraudulent practices by others, negating the benefits.” These practices could include “greenwashing”—the practice of misrepresenting the carbon emissions related to projects or activities in order to obtain cheaper financing, the article noted.
The officials also warned about financial stability risk associated with the transition to the low carbon economy. They noted that that the green transition presents a two-sided risk to financial stability, as institutions must manage both their exposures to overvalued “brown” assets, which could lose value during the transition, as well as exposures to either overvalued “green” assets, or to assets that purport to be green, which the BIS officials noted could cause “green bubbles.”
“The primary role of private financial markets is to reflect the underlying condition of the real economy,” the authors said. “Thus, it would be unrealistic to expect them to induce the green transition unless the right signals come from the real economy. Unrealistic expectations can set the financial sector up for failure and derail the transition. As a key channel for the reallocation of resources, the financial sector has an essential supporting role to play and must avoid adding to transition risk.”