Banks need financial incentives to tackle climate change, warns chief supervisor

Attempts to convince banks to counter climate change will fall short without financial incentives such as a global carbon tax, a leading regulator overseeing policy in the area has warned.

Dietrich Domanski, who as secretary-general of the Financial Stability Board helped to oversee attempts to put green issues to the fore in banking, said in a valedictory interview with the Financial Times: “In the end we are talking about profit-orientated institutions.”

“As long as you do not provide the necessary price signals, which then translate into profits or profit expectations, there is a limit to what one can expect,” he said, adding that those “price signals” would “ideally [be] a global carbon tax”.

Domanski’s candid remarks come after a bruising year for banks and their regulators over climate-related reforms. A number of US lenders threatened to quit Gfanz, the green alliance set up by Mark Carney, amid fears of being sued over increasingly stringent decarbonisation commitments. Top global banks cut their fossil-fuel funding only slightly in 2021, despite a flurry of public commitments.

Domanski also took aim at supervisors’ increasing use of stress test exercises to police climate risk. Domanski said a “market-based solution” was likely to prove more effective than spending time on “detailed and very expensive planning” exercises into how climate change might pan out.

The BoE carried out stress tests that predicted up to £225bn of climate-related losses among the UK’s top banks, while the ECB reviewed its banks’ exposure and warned they had “significantly” understated climate risks.

The outgoing secretary-general of the FSB, which is responsible for studying global risks to financial stability and devising policies to mitigate them, said climate change was one of the topics that dominated this year’s meetings of finance ministers, regulators and central bankers in Basel. Others were cryptocurrency, rising interest rates and the sharp growth in non-bank financial institutions.

Global co-operation on financial services regulation peaked in the aftermath of the great financial crisis, when policymakers came together to deliver a landmark package of banking reforms that forced a sea change in how banks assessed and prepared for risks.

The final piece of the post-crisis package, known as Basel 3.1 to regulators but often referred to as Basel 4, was due to come into force in January 2023. But its implementation has been delayed by two years in major markets, including the EU and the UK.

The EU has proposed so many deviations to the originally deal that its own regulators warned the bloc risked being deemed “materially non-compliant”.

Asked if the EU’s deviations could cast doubt on the coherence of post-crisis global policymaking, Domanski said that if a major jurisdiction departed from the global framework “my view is that it does raise questions”. He added that the impact would depend on a “separate question” on the extent of the deviations, and how “important” the differences were.

“After a global crisis in 2008, in the face of this huge unprecedented shock, there was a clear and very strong sense of the need to act [decisively] at global level,” Domanski said. “As the memory of that crisis fades, that sort of momentum becomes less strong.”

Still, he said that there was “absolutely no complacency” and that regulators were “mindful of the vulnerabilities that are out there and that may crystallise as a result of the very challenging environment.”

The FSB’s key climate change road map, published in the middle of last year, called for regulators to seek better climate-related data from the financial sector, to conduct analysis of financial institutions’ vulnerabilities to climate change, and to monitor those risks.

Some national and regional regulators, notably the EU, have mooted more dramatic measures. Those include creating “green supporting factors” to give preferential regulatory treatment for the financing of environmentally-friendly projects, or “brown penalising” ones that pull from a different direction.