EU Parliament report urges ECB to limit bank exposure to high-carbon firms

The study will inform an upcoming discussion between the ECB and the ECON committee.

A paper commissioned by a European Parliament committee has proposed that the European Central Bank (ECB) introduce exposure limits to carbon-intensive companies for EU banks.

The paper, published last week, is part of a trove of expert analysis produced to serve the quarterly Monetary Dialogue between the ECB and the parliamentary Committee on Economic and Monetary Affairs (ECON). The meeting is the primary mechanism through which the ECB is held accountable to the parliament.

The paper will feed into the final ECB-ECON session for 2023, due to take place on 27 November. It recommends that the ECB consider introducing rules that would limit the financial exposure to polluting companies to a suggested “50 or 75 percent of a bank’s eligible capital”.

Author Dirk Schoenmaker, a banking and finance academic at Erasmus University Rotterdam, likened the proposed policy to that of the large exposure regime, which in the EU limits a bank’s exposure to individual or affiliated clients to a quarter of its capital reserves. The regime is intended to prevent banks from incurring disproportionately large losses from the failure of an individual client or group of connected clients.

While large exposure rules are set at an institutional level against individual companies, large climate-exposure rules should be set at the macro level against aggregate exposures, which would then be cascaded to banks, said Schoenmaker.

He argued that such a policy is needed to counteract the existing carbon bias of the financial system, which is reinforced through the ECB’s “market neutral” approach of buying securities in proportion to the market index. Market indices for equities and corporate bonds, and bank lending, are typically overweight on polluting companies due to the capital-intensive nature of their business.

Such a bias has long been observed and has raised questions in recent years about how supervisors should integrate climate considerations within their monetary and fiscal operations – or explicitly in mandates – to avoid creating more favourable financing conditions for carbon-intensive activities.

Catherine Mann, a monetary policy committee member of the Bank of England, warned central banks in a speech last week that either inaction or action on climate change would impact the efficacy of monetary policy operations and that such effects needed to be better understood.

“When climate change has macroeconomic effects – whether physical impacts from extreme weather events and higher average temperatures or transition effects associated with transforming to a net-zero economy, including explicit implications for inflation – it becomes a concern for monetary policymakers,” said Mann.

“That applies whether the monetary policymaker’s remit includes a reference to climate change or not.”

Separately, Schoenmaker has proposed that the ECB introduces limits to the share of high-carbon assets it will accept as collateral against its lending to banks. The European supervisor is in the process of applying such rules to corporate bonds and bank loans but has yet to do so for bank bonds and asset-backed securities, which form half of the collateral pool.

Another suggested policy measure is that the ECB should lower interest rates on refinancing operations for banks in order to incentivise lending for clean-energy production and energy-efficiency operations.

However, the paper notes that fiscal measures, such as establishing a significant carbon tax, will be “far more powerful in mitigating climate change than any monetary policy low-carbon allocation can ever be”.

Clarisse Murphy, a central banks campaigner at Reclaim Finance, said: “This paper is a timely reminder that climate change could seriously jeopardise inflation management and should not be sidelined in the ECB annual report, as some MEPs are currently suggesting.”

Murphy added that the proposed measure of introducing targeted lower interest rates would be “much needed to lower the costs of going green”.

An ECB spokesperson declined to comment on the report’s recommendations in view of the upcoming ECON hearing.