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Green swans: a tipping point for global finance

Luiz Awazu Pereira Da Silva
Deputy General Manager of Bank of International Settlements
Key takeaways
  • Inspired by the “black swan,” a concept referring to rare, unpredictable events with an extreme impact, the “green swan” refers to events due to climate change, which we know with certainty will occur more and more often in the future.
  • The green swan concept emerged through discussions in central banking networks, concerned with the financial instability that could arise from such repeated and intertwined climate-related events.
  • What can supervisors and regulators do to reduce these risks? Beyond voicing their concerns, tools such as asset classification can accelerate the energy transition.
  • But as powerful as central bankers’ ability to direct financial flows may be, the most decisive tools, notably the price of carbon, remain in the hands of governments.
  • The major challenge today is coordination between institutional players whose responsibilities and constraints do not align.

Where does the concept of the green swan come from, and how did it come about?

The con­cept emerged with­in the Bank for Inter­na­tion­al Set­tle­ments, an insti­tu­tion whose man­date includes coor­di­na­tion between cen­tral banks and there­fore finan­cial sta­bil­i­ty. We took inspi­ra­tion from “black swan,” a notion devel­oped by Nas­sim Nicholas Taleb, which evokes the extreme impact of cer­tain types of rare and unpre­dictable events. Taleb’s book was pub­lished in 2007, just before the finan­cial cri­sis that came as an illus­tra­tion of his idea.


For Taleb, although events of this type do some­times occur, their prob­a­bil­i­ty remains low. They are con­fined to the tail of the dis­tri­b­u­tion of a fair­ly clas­si­cal Gauss­ian prob­a­bilis­tic uni­verse. The idea of “green swans”, how­ev­er, is an epis­te­mo­log­i­cal break from this dis­tri­b­u­tion because cli­mate change is turn­ing the tables. We now know with cer­tain­ty that extreme impact events will occur in the com­ing decades. We also know, and this is quite wor­ry­ing, that if we do noth­ing to reverse the course of this evo­lu­tion, points of no return will be reached, with inter­twined con­se­quences. For exam­ple, ris­ing sea lev­els will direct­ly affect many coastal urban areas, with cas­cad­ing con­se­quences: some will become unin­hab­it­able, oth­ers will require huge invest­ments, prop­er­ty prices will suf­fer shocks, and insur­ance costs will increase. Sim­i­lar­ly, the intertrop­i­cal zone could become unin­hab­it­able if days of over 45°C become per­ma­nent rather than excep­tion­al. Here again, the demo­graph­ic, eco­nom­ic and polit­i­cal con­se­quences are inter­twined and can become very dif­fi­cult to man­age: one cri­sis leads to anoth­er, and so on. Just as in 2008 the very sharp cor­rec­tion in the US prop­er­ty mar­ket degen­er­at­ed into a bank­ing cri­sis, then a glob­al finan­cial cri­sis, then a euro cri­sis, then a polit­i­cal cri­sis with the rise of populism.

This brings us to the idea of the “green swan”: events with extreme impact will occur, whose con­se­quences will inter­twine as they become more frequent.

This epistemological reversal of the black swan model directly challenges the community of financial supervisors and regulators. Within the area of central banking, how do you get a hold on these emerging risks?

At the BIS, we have sculpt­ed this debate through the lens of finan­cial sta­bil­i­ty, because that is the core of our man­date. To put it sim­ply: these events pro­duce loss­es on the bal­ance sheets of finan­cial insti­tu­tions (banks, insur­ance com­pa­nies, pen­sion funds). These poten­tial­ly huge loss­es are some­times unin­sured. Finan­cial insti­tu­tions are not yet able to absorb them (notably because they do not have enough equi­ty). There is there­fore a risk of crisis.

Oth­er play­ers in our field have tak­en this think­ing a step fur­ther, by look­ing at price sta­bil­i­ty: for exam­ple, drought affects agri­cul­tur­al pro­duc­tiv­i­ty and thus caus­es inflation.

There is a third lev­el of think­ing: “tran­si­tion risks.” When we start to con­sid­er new con­straints, in this case CO2 emis­sions, we must acknowl­edge that imple­ment­ing new reg­u­la­tions might lead to a whole series of shocks: some indus­tries’ val­ue will increase, oth­er indus­tries’ val­ue will decrease, some may even dis­ap­pear or see their eco­nom­ic mod­el dra­mat­i­cal­ly dis­rupt­ed. These shocks will result in changes in the banks’ bal­ance sheets. A sim­ple change in reg­u­la­tions can cause a sharp decline in the val­ue of cer­tain assets. It is pos­si­ble to antic­i­pate this effect – the oil com­pa­nies, for instance, are work­ing on it. But still, a mass sale of their shares would influ­ence finan­cial stability.

We are not talk­ing here about “sim­ple” finan­cial crises, which are tra­di­tion­al­ly the domain of cen­tral banks; we are talk­ing about some­thing else.

Fourth lev­el of reflec­tion: asset clas­si­fi­ca­tion, with the risk of mis­clas­si­fi­ca­tion. A tran­si­tion pol­i­cy requires a reori­en­ta­tion of invest­ment flows towards cer­tain activ­i­ties. Clas­si­fi­ca­tion is thus a pow­er­ful tool, since they guide mas­sive invest­ments. But some clas­si­fi­ca­tions are not pre­cise enough as they mix var­i­ous cri­te­ria. This makes it dif­fi­cult for investors to dis­cern and make the right moves. One exam­ple is ESG (envi­ron­men­tal, social and gov­er­nance) cri­te­ria. Yet clas­si­fi­ca­tions guide mas­sive quan­ti­ties of invest­ments. Even­tu­al­ly, very pre­cise cri­te­ria will be need­ed to avoid green­wash­ing. In par­tic­u­lar it should be manda­to­ry for each and every com­pa­ny to pre­cise­ly assess and dis­close its car­bon foot­print, along with its strat­e­gy to get clos­er to car­bon neu­tral­i­ty. It is the role of super­vi­sors and reg­u­la­tors to ensure that this infor­ma­tion is increas­ing­ly avail­able and gran­u­lar. At the BIS, we have start­ed to build port­fo­lio models.

The ques­tion of clas­si­fi­ca­tions and new cri­te­ria has giv­en rise to an unre­solved debate with­in cen­tral bank­ing cir­cles: how should cen­tral banks take these new cri­te­ria into account when they buy back assets, or when they accept col­lat­er­al? Cen­tral banks can­not do every­thing, but they do play a cru­cial role in finan­cial sta­bil­i­ty and their instru­ments are so pow­er­ful that they will play a role in the ener­gy tran­si­tion. Nonethe­less the main instru­ment of the tran­si­tion, set­ting a price for car­bon, is out of their reach: such respon­si­bil­i­ty belongs to gov­ern­ments. Some cen­tral bankers con­sid­er that it is their duty to act since gov­ern­ments are not doing enough, while oth­ers point to the risk of moral haz­ard: if cen­tral banks decide to act, gov­ern­ments will do even less.

How­ev­er pow­er­ful the insti­tu­tions in charge of finan­cial sta­bil­i­ty may be, and how­ev­er advanced they may be in under­stand­ing new risks, they can­not act alone. They can­not sub­sti­tute for pol­i­cy; in fact, the oppo­site is true. We are not talk­ing here about “sim­ple” finan­cial crises, which are tra­di­tion­al­ly the domain of cen­tral banks; we are talk­ing about some­thing else.

No sin­gle actor will be able to pro­vide the answer. The first chal­lenge for action is coor­di­na­tion, which brings us direct­ly back to the work of Nobel Prize-win­ning econ­o­mist Eli­nor Ostrom on the gov­er­nance of the com­mons. We need to get our act togeth­er, to set an orga­ni­za­tion so that sci­ence can play a role. Here I shall add an essen­tial point: we must act as if there will be no alter­na­tive tech­nol­o­gy and ensure that the cost of insur­ance is available.

A key challenge, though, is to develop and disseminate the technologies that will enable us to achieve carbon neutrality.

Indeed. And this con­cerns both pri­vate and pub­lic invest­ments. We need to mobi­lize pub­lic cap­i­tal and not just direct pri­vate cap­i­tal flows. Alliances will also be need­ed. These have begun to devel­op – think of the Glas­gow Finan­cial Alliance for Net Zero, which was launched in 2021 and brings togeth­er finan­cial insti­tu­tions, or the Net­work for Green­ing the Finan­cial Sys­tem (NGFS), a net­work of more than 100 cen­tral banks and finan­cial super­vi­sors that aims to accel­er­ate the scal­ing up of green finance and to devel­op rec­om­men­da­tions on the role of cen­tral banks in cli­mate change.

We must act as if there will be no alter­na­tive tech­nol­o­gy and ensure that the cost of insur­ance is available.

The role of these alliances is to push for a change in prac­tices and the imple­men­ta­tion of new instru­ments, but also to dis­cuss them. This forum for­mat is essen­tial to bring out prob­lem­at­ic aspects, for it is a cru­cial issue to imag­ine the unimag­in­able. The NGFS has made a point of devel­op­ing “dis­cor­dant” sce­nar­ios, includ­ing the “dis­or­der­ly tran­si­tion”: the sit­u­a­tion keeps dete­ri­o­rat­ing and adjust­ments are made too late, with every investor rush­ing to sell their “brown” assets. In this sce­nario, ser­i­al bank­rupt­cies lead to a finan­cial cri­sis. The reflec­tion is there­fore on how to start an order­ly tran­si­tion, with a form of eco­log­i­cal plan­ning and coor­di­na­tion of actors.

The cur­rent rise in ener­gy prices dri­ves us in the right direc­tion, but it also reminds us of the impor­tance of redis­trib­u­tive poli­cies, since some social groups are par­tic­u­lar­ly exposed to ener­gy price increas­es. Nev­er­the­less, the cur­rent shock is an oppor­tu­ni­ty that should be seized: how can we use this change in rel­a­tive price as an incen­tive to accel­er­ate the transition?

If we want to seri­ous­ly address these issues, all play­ers involved need to work togeth­er and con­sid­er the dif­fer­ent dimen­sions of the tran­si­tion. Such coor­di­na­tion is far from easy, since it implies a com­bi­na­tion of long and short cycles. The short cycles of pol­i­tics, par­tic­u­lar­ly, might arise the “tragedy of the hori­zon.” And we should not for­get the “tragedy of com­mons,” with the risk of free rid­ers leav­ing the efforts to others.

Final­ly, at the glob­al lev­el, inter­na­tion­al coor­di­na­tion inevitably requires sup­port from the most advanced coun­tries, either through tech­nol­o­gy trans­fer or via an invest­ment fund. The last COP result­ed in the promise of a $100 bil­lion fund, but it is too little.

Inter­view by Richard Robert


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