The Covid pandemic, the crisis linked to the war in Ukraine and the challenges posed by climate change present central banks with a complex challenge: to steer and control inflation that is constantly rising. The European Central Bank’s (ECB) objective is to achieve 2% inflation in the medium term – compared with 3% in Europe today – but without curbing the investments needed for the energy transition.\n\n\n\nInflation rates in Europe. Source: Eurostat[pi_note]https://ec.europa.eu/eurostat/databrowser/view/tec00118/default/line?lang=fr[/pi_note].\n\n\n\nOn the one hand, the scale of the investments required to meet climate objectives is colossal.\n\n\n\nOur remaining global carbon budget, which represents the CO2 emissions compatible with the Paris Agreement, would be 580 GtCO2 for a 50% probability of keeping warming below 1.5°C according to the estimates of the IPCC report[pi_note]Rogelj, J., Forster, P., Kriegler, E., Smith, C., Séférian, R. (2019). Estimating and tracking the remaining carbon budget for stringent climate targets. Nature 571, 335–342. [/pi_note]. On average, annual global anthropogenic emissions are around 40GtCO2 (Global Carbon Project, 2022). At this rate, this carbon budget would be exhausted in less than 15 years. On the other hand, the sources of inflation today are multiple, from the disorganisation of value chains during the pandemic to the imbalance between supply and demand at the end of the crisis. In addition, the rise in energy prices linked to the war in Ukraine and energy transition policies are fuelling “green inflation”[pi_note]Schnabel, I. (2022). Looking through higher energy prices ? Monetary policy and the green transition. Speech at the panel on “Climate and the Financial System” at the American Finance Association 2022 Virtual Annual Meeting.[/pi_note].\n\n\n\nResidential electricity prices. Half-yearly data 2007-2022, EU27. Source: Eurostat[pi_note]https://ec.europa.eu/eurostat/databrowser/view/nrg_pc_204/default/line[/pi_note].\n\n\n\nIs it legitimate for central banks to take up the issue of combating climate change? This question was already raised by Milton Friedman in 1970 regarding the environmental and social responsibility of companies, when he questioned the political legitimacy of company directors to provide public goods[pi_note]Friedman M. (1970). The Social Responsibility Of Business Is to Increase Its Profits. The New York Times Magazine, September 13, 1970. Section SM, Page 17.[/pi_note]. However, in terms of the fight against climate change, we are faced with a double failure to integrate climate risk: the failure of markets but also the failure of governments[pi_note]Crifo P., Forget V. (2015). The economics of corporate social responsiiblity : a firm-level perspective survey. Journal of Economic Surveys Vol. 29, No. 1, pp. 112–130.[/pi_note].\n\n\n\nMobilisation of central banks\n\n\n\nThe expectations of economic and financial actors and regulators are legitimate. But this does not mean that central banks should replace governments.\n\n\n\nTotal global CO2 emissions. Source: Friedlingstein et al. 2022; Global Carbon Project 2022[pi_note]Friedlingstein et al 2022 ; Global Carbon Budget https://essd.copernicus.org/articles/14/4811/2022/[/pi_note].\n\n\n\nIllustration of the estimate of the remaining carbon budget. This estimate is based on the historical human-induced global warming level, the net zero commitment, the contribution of future warming without CO2 (consistent with global net zero emissions or not), the transient climate response to cumulative carbon emissions (TCRE), and the additional correction for unrepresented Earth system feedback. The grey area illustrates how the uncertainty in the TCRE propagates from the starting point. Source: Rogelj et al. (2019)[pi_note]Rogelj, J., Forster, P., Kriegler, E., Smith, C., Séférian, R. (2019). Estimating and tracking the remaining carbon budget for stringent climate targets. Nature 571, 335–342. [/pi_note].\n\n\n\nThe need for central banks to mobilise in the fight against climate change is twofold: climate change is a threat both to economic activity and to financial stability. It is therefore an integral part of the central bank's mandate. Indeed, the TCFD report[pi_note]TCFD - Task Force on Climate-Related Financial Disclosures.Créée en 2015 dans le contexte de la COP 21 et sous l’égide du Conseil de stabilité financière (FSB), la TCFD vise à aider les entreprises à fournir de meilleures informations extra-financières. Elle publie à l’été 2017 onze recommandations, s’articulant autour de quatre piliers qui représentent des éléments fondamentaux du fonctionnement des organisations : la gouvernance, la stratégie, la gestion des risques et les mesures et objectifs. La TCFD fait partie des lignes directrices de 2019 de la Commission européenne en matière de reporting extra-financier[/pi_note] by the Banque de France and the ACPR in 2022 begins:\n\n\n\n“Contributing to assessing, reducing, and managing the impact of climate risks on the real economy and the financial system is in our view an integral part of the mandate of central banks and supervisors, both in terms of monetary strategy and financial stability. The Banque de France has therefore been an early advocate for the community of central bankers and supervisors to take climate change issues into account. Internationally, it was one of the founding members of the Network of Central Banks and Supervisors for the Greening of the Financial System (NGFS)[pi_note]NGFS -Network for Greening the Financial System (NGFS). Le groupe des régulateurs sur la finance verte créé en décembre 2017 au One planet summit par 8 Banques Centrales et régulateurs (dont la Banque de France) réunit en octobre 2022 121 membres et 19 observateurs au niveau mondial.[/pi_note] in 2017, which now has 121 members and for which it provides the global secretariat.”\n\n\n\nWhat is climate risk in finance?\n\n\n\nClimate risk in finance is defined in terms of two main components: physical risk and transition risk (Carney, 2015). Physical risk represents the economic and financial costs incurred because of the increasing severity and frequency of physical climate hazards. Transition risk, on the other hand, results from changes in government policies, technological changes and changes in investor and consumer behaviour.\n\n\n\nThe transition to a low-GHG economy requires rapid and far-reaching transitions in energy, land use, urban planning, infrastructure, and industrial systems. €830 billion per year would be needed to make this transition[pi_note]IPCC (2018). Réchauffement planétaire de 1,5 °C, Résumé à l’intention des décideurs, 2018.[/pi_note].\n\n\n\n\n€830 billion per year would be needed to ensure the transition to a low-GHG economy.\n\n\n\n\nSome sectors may lose much of their value or even disappear in the coming decades (referred to as stranded assets). Studies[pi_note]McGlade, C., Ekins, P. (2015). The geographical distribution of fossil fuels unused when limiting global warming to 2 °C. Nature 517, 187–190.[/pi_note] estimate that a policy to limit global warming to 2°C would mean that 35% of oil reserves, 52% of gas reserves and 88% of coal reserves would become unusable. In this context, should we then continue to invest capital in the search for and exploitation of these reserves? These investments risk becoming unusable, very expensive, and possibly totally depreciated.\n\n\n\nAll these changes can generate losses identifiable through traditional financial risks: credit (subject-sensitive borrowers), market (asset valuation), liquidity (access to bank finance) or operational (compliance and regulatory risk).\n\n\n\nIn terms of inflation – a core mandate of the Central Bank – the physical risks of climate change lead to negative supply shocks (capital destruction, reduced labour supply, productivity uncertainties) that reduce potential output, increase output gaps and inflationary pressures. An increase in the frequency and severity of these negative supply shocks could lead to increased volatility in headline inflation and, under certain circumstances, could affect inflation expectations[pi_note]Dées S., Weber PF (2020). Les conséquences du changement climatique pour la politique monétaire », Revue d'économie financière, 2020/2 N° 138, p. 243-257. [/pi_note]. \n\n\n\nACPR stress tests\n\n\n\nThe ACPR (Autorité de contrôle prudentiel et de régulation), conducted a pilot climate stress test in 2021 that highlights the exposure to climate risk in France of 9 banking groups and 15 insurance groups, which together account for 85% of the total balance sheet of banks and 75% of the total balance sheet of insurers in France. This exercise shows that, for the insurance sector, the cost of climate-related claims should be multiplied by 5 or 6 between 2020 and 2050 in certain departments (particularly in the west of France).\n\n\n\n\nThe cost of weather-related claims should be multiplied by 5 or 6 between 2020 and 2050.\n\n\n\n\nThe main hazards contributing to this increase in claims are related to the risk of drought and flooding, and the increased risk of cyclonic storms in the overseas territories. If this risk were to be offset by an increase in premiums, insurance premiums would have to increase by 130 to 200% over 30 years, i.e. 3 to 3.7% per year[pi_note]ACPR (2021) Une première évaluation des risques financiers dus au changement climatique. Les principaux résultats de l’exercice pilote climatique 2020.[/pi_note].\n\n\n\nIntegrating climate risk into financial issues\n\n\n\n\nTo integrate climate risk into financial stability monitoring, prudential supervision and portfolio management, the central bank has several tools at its disposal (see for example the recommendations of NGFS, 2019[pi_note]NGFS (2019). Un appel à l’action Le changement climatique comme source de risque financier. Réseau pour le verdissement du système financier. Premier rapport complet[/pi_note]):\n\n\n\nEconomic and financial analysis (taking climate change into account in its models, macroeconomic projections, and risk assessment).\n\n\n\nBanking and insurance supervision (raising awareness and ensuring that banks and insurers manage climate risk adequately).\n\n\n\nMonetary policy and investment portfolios (central banks can invest in green bonds, for example).\n\n\n\nPrudential and financial stability measures (e.g. on capital requirements and sectoral leverage ratios).\n\n\n\n\nThe climate strategy of the Banque de France and the ACPR is thus embodied in all of the institution’s missions (monetary strategy, financial stability, services to the economy and society and sustainable performance). Five strategic climate actions are dedicated to priority areas: adapting monetary policy operations to climate risks, increasing the financial sector's consideration of climate risk, assessing the integration of climate risks into company ratings, actively committing to carbon neutrality, and aiming for digital sobriety in all uses[pi_note]ACPR (2022) L’action climat de la Banque de France et l’ACPR. Rapport TCFD. [/pi_note].