Aligning financial and monetary policies with the concept of double materiality: rationales, proposals and challenges

The concept of double materiality is developing rapidly, with potential implications for monetary and financial policies. Double materiality builds on the historical accounting and auditing convention of materiality and expands it by considering that non-financial and financial corporations are not only materially vulnerable to environment-related events and risks, but also materially contribute to enabling dirty activities and environmental degradation.

Three rationales that support the use of double materiality are distinguished in this paper, each with different policy implications: i) an idiosyncratic perspective – closely connected to the concept of dynamic materiality – which considers that an entity’s environmental impacts are relevant as they provide information on the institution’s own risks; ii) a systemic risk perspective – closely connected to the concept of endogeneity of financial risks – which seeks to reduce financial institutions’ contribution to negative environmental externalities because of the systemic financial risks that could result from them; and iii) a transformative perspective seeking to reshape financial and corporate practices and values in order to make them more inclusive of different stakeholders’ interests and compatible with the actions needed for an ecological transition. Each of these rationales has potential implications for monetary and financial policies, as well as possible theoretical and practical challenges.

While the adoption of a double materiality perspective remains an open question, the concept proposes the opportunity to think more comprehensively about the role of the financial system in urgently addressing the ecological challenges of our times.


This paper is part of a toolbox designed to support central bankers and financial supervisors in calibrating monetary, prudential and other instruments in accordance with sustainability goals, as they address the ramifications of climate change and other environmental challenges. The papers have been written and peer-reviewed by leading experts from academia, think tanks and central banks and are based on cutting-edge research, drawing from best practice in central banking and supervision.

Central banks and climate-related disclosures: applying the TCFD’s recommendations

Central banks are increasingly exploring how climate-related financial risks and opportunities impact their price and financial stability mandates, as well as their own operations. They are also beginning to consider how their own actions, and those of the financial institutions they supervise, may contribute to and exacerbate climate change risks and opportunities.

Measuring and reporting – or disclosing – climate-related risks and opportunities is a key step in addressing these issues, for both individual institutions and the financial system as a whole. With this recognition, the Task Force on Climate-related Financial Disclosures (TCFD) was established, to guide financial institutions to make effective climate disclosures. The development of high quality, reliable, comparable and transparent climate disclosures can support decision-making and enable better understanding of the implications of climate change for central banks. Further, central banks can lead by example by demonstrating lessons learned from their own climate-related disclosures to other financial institutions and by using their influence over the financial rulebook to build the broader system architecture.

This paper reviews key elements of the recommendations made by the TCFD – first released in 2017 – and their application by central banks to date. The paper also considers potential enhancements for central banks’ climate disclosures and their possible implications for the wider financial system. The fact that definitions, data, and methodologies for assessing climate-related issues are constantly evolving means that efforts to develop climate-related disclosures will need to follow a progressive approach, with the quantity and quality of disclosures improving in parallel with the progress made in these areas. A flexible framework also suits the distinct operational models and different mandates of central banks.

The recommendations made in this paper can be applied to the different central bank portfolios, including monetary and non-monetary and credit facilities, as well as financial stability and physical operations. They are designed to support a wider and more practical application of the TCFD recommendations by central banks.


This paper is part of a toolbox designed to support central bankers and financial supervisors in calibrating monetary, prudential and other instruments in accordance with sustainability goals, as they address the ramifications of climate change and other environmental challenges. The papers have been written and peer-reviewed by leading experts from academia, think tanks and central banks and are based on cutting-edge research, drawing from best practice in central banking and supervision.

Developing a precautionary approach to financial policy – from climate to biodiversity

Climate change and biodiversity loss have primarily been approached by financial authorities (central banks and supervisors) from the perspective of financial risk. The prevailing view is that there is insufficient information and understanding of environment-related financial risks within financial institutions. If such financial risks can be discovered, measured and disclosed, they can be priced into financial markets to support a smooth environmental transition and this market failure can be addressed.

However, environment-related financial risks have particular features that make them less amenable than other types of risk to standard financial risk management approaches. In particular, the ‘radical uncertainty’ characterising the long time horizons and the endogenous and non-linear dynamics involved with environmental change make quantitative calculations of financial risk challenging, if not impossible.

The authors propose in this paper an alternative, precautionary approach to financial policy, incorporating both prudential and monetary policies. As a framework it draws on the ‘precautionary principle’ and modern macroprudential policy traditions. A precautionary financial policy mindset acknowledges the importance of measurement practices and price discovery but justifies bolder policy action to shift the allocation of capital to shorter time frames better aligned with the uncertain and potentially catastrophic nature of environment-related threats, including the risks to, and posed by, financial institutions. The paper considers financial authorities’ tentative steps and possible tools in such a precautionary policy direction – and how these could be scaled up and mainstreamed.


This paper is part of a toolbox designed to support central bankers and financial supervisors in calibrating monetary, prudential and other instruments in accordance with sustainability goals, as they address the ramifications of climate change and other environmental challenges. The papers have been written and peer-reviewed by leading experts from academia, think tanks and central banks and are based on cutting-edge research, drawing from best practice in central banking and supervision.

Inflation and climate change: the role of climate variables in inflation forecasting and macro modelling

Climate change is increasingly affecting the objective, conduct and transmission of monetary policy. Yet, climate-related shocks and trends are still generally absent from the canonical models used by central banks for their policy analysis and forecasting. This briefing paper reviews the potential pitfalls of using a modelling framework that omits climate-related information and provides some reflections on how central banks can integrate climate change considerations into their ‘workhorse’ models.

This includes: accounting for an explicit role of the energy sector in the production structure and for specific climate change policies; improving the ability of models to cope with various sources of heterogeneity; and incorporating a more realistic representation of the financial sector, to analyse the possible stranding of assets and impairments in the transmission mechanism of monetary policy. It argues that a ‘suite-of-models’ strategy is a promising approach for central banks to cope with the climate challenge when designing a new generation of models.

To complement theory with practice, several examples of central banks that have already integrated climate-related information into their analytical frameworks are provided. The paper concludes with some specific recommendations.

 


This paper is part of a toolbox designed to support central bankers and financial supervisors in calibrating monetary, prudential and other instruments in accordance with sustainability goals, as they address the ramifications of climate change and other environmental challenges. The papers have been written and peer-reviewed by leading experts from academia, think tanks and central banks and are based on cutting-edge research, drawing from best practice in central banking and supervision.

Changes in rainfall, agricultural exports and reserves: macroeconomic impacts of climate change in Argentina

Most of the articles that analyze the macroeconomic impact of the physical risks of climate change focus on discrete, one-time events such as floods, hurricanes and draughts. This paper studies a long-term manifestation of physical risks (namely, changes in rainfalls) and its macroeconomic impacts in a developing country such as Argentina. We document a downward trend in rainfalls in the main agricultural area of Argentina, using daily data starting in 1970. We further use changes in rainfall as an instrument for on the export performance of the main agricultural complexes: soy, wheat, corn and sunflower, from 2003 to 2019. Using an instrumental variable approach, we study the impact of changes in rainfall on foreign exchange reserves, controlling for economic activity, capital flows and debt repayments. We find that drops in rainfall in the months of January (mainly) and February are significantly associated with lower reserve accumulation by the central bank. This result is robust to several specifications.

The exposure of financial institutions to risks from a transition to a low-carbon economy

This workshop shall address some of the limitations in current modelling approach, with a focus on transition risks. The programme will be divided into two consecutive sessions: Session I focuses on scenario applications for evaluating transition risks for financial institutions and Session II is orientated around scenario calibration and modelling methodologies.
Contributions from: Gregor Semieniuk – UMASS;
Rick Van Der Ploeg – University of Oxford;
Edo Schets -Bank of England;
Stephane Dees – Banque de France;
Ulrich Volz – SOAS
Stefano Battiston – UZH
David Carlin – UNEP-FI
Maarten Vleeschhouwer -2 Degrees Investing Initiative
Christophe McGlade – IEA
Christoph Bertram – PIK
Massimo Tavoni – PoliMi), Alex Koberle (Imperial College London), James Edmonds (PNNL), Michael Grubb (UCL) and Jean-Francois Mercure (University of Exeter)

NGFS-GRASFI-INSPIRE exchange – Climate-related financial policy in a world of radical uncertainty

Josh Ryan-Collins (University College London) will present his research “Climate-related financial policy in a world of radical uncertainty – towards a precautionary approach co-authored with Hugues Chenet (University College London) and Frank van Lerven (New Economics Foundation).

The NGFS-GRASFI-INSPIRE exchange is designed to strengthen the connection, collaboration and research exchange between the central bankers, financial supervisors and the academic community to share and explore new and innovative research that advances the agenda on greening the financial system. New editions occur monthly and are co-organised by the NGFS Secretariat, INSPIRE and GRASFI (the NGFS’ two designated global research stakeholders). This 2nd edition is hosted by INSPIRE.

 

Supervision beyond the business cycle: A framework for long-term financial supervision

Financial supervisory mandates are interpreted to ensure financial stability ‘over the business cycle’ (three to five years). New risks are challenging this paradigm, as they manifest themselves both over longer time horizons and as secular, one-directional shocks. We have designed this exploratory conceptual project to identify potential mechanisms and levers financial supervisors can mobilise in order to ‘supervise the long-term’ and reframe their mandate to cover more long-term risks.

Current financial policy and supervisory analysis falls into two categories. In the first category, financial policy analysis seeks to identify potential levers within the mandate to supervise risks over the business cycle (e.g., capital requirements) or support societal goals. The second category involves the development of tools to analyse the financial materiality of long-term risks (e.g., climate scenario analysis). Missing within this paradigm is the ‘adapter’ that allows for the integration of the second category of analysis into mainstream supervisory frameworks. As a result, stress tests looking out to 2030 are intellectually satisfying, but remain largely theoretical exercises.

We seek to begin to fill this gap by suggesting a framework for what long-term financial supervision could look like that would allow for the integration of these long-term risk assessments, as well as the steering of policy levers beyond business cycle risk management. This requires a review of both existing and potential new policy instruments, as well as more general questions over how such policy could work (including related to the arbitrage between short-term and long-term risks).

The primary output of our research will be a discussion paper focused on two central questions:

  • What are the instruments to enhance the supervision of long-term risks?
  • How might governance and mandates need to change to support the supervision of long-term risks?