To transition to a low-carbon economy, banks and other financial institutions will need to shift billions of pounds away from fossil fuels and ensure they fill the ‘gap in green investment’. It’s clear, however, that a changing climate threatens the profits and stability of the private financial sector, either through physical damage from weather events or revaluations caused by technological or policy changes.

Central banks, as coordinating institutions at the heart of the financial system, are aware that they have a role to play in managing these issues. The Bank of England and other central banks currently see their task as ensuring that climate change and the low-carbon transition do not damage financial stability. Encouragingly, this discussion is accelerating fast through central banks, academia, civil society and the mainstream media - including the financial press.

In the UK, action is being taken by The Bank of England which in April 2019 announced it would disclose its own climate risk after significant pressure from civil society and academics. This is radical. Central banks are historically orthodox and establishment institutions steeped in mainstream economics, which itself does not recognise how the market failure of climate change points to huge flaws in orthodox economics. Impressively it is now mainstream to argue that climate change and society’s response to it create risks that threaten the stability of the financial system.

Whilst that shift is welcome, if it is the only approach taken the Bank runs the risk of leaving meaningful action until it is too late. Unless it considers the long-term viability of the economy, concern for climate risk looks incoherent. Currently Bank officials reject the arguments put forward by many in civil society calling for their assistance in raising investment for the low-carbon transition. Central banks are public institutions responsible for regulating finance, so should contribute towards closing the green investment gap. Considering climate change only as a financial stability risk will not be sufficient for meaningful action.

A Green New Deal must also look to ensure that throughout a green transition the economy is made more equitable and equal. Power cannot stay as it has been: concentrated. If we’ve learned anything from the 2008 global financial crisis, it’s that the instability of the financial system will always undermine social and environmental progress. That means we can’t deliver the ambitious Green New Deal we need to whilst maintaining the status quo: a financial sector which is inherently extractive, rent-seeking, and concentrates wealth and power among fewer and fewer hands.

One of the key problematic design features of the current money and banking system is how commercial banks have abused their power to create new money when they lend. By pumping 80% of new loans into property and financial markets1, they have inflated asset bubbles whilst fuelling wealth inequality and building up a private debt mountain, exposing the economy to financial instability. At the same time, they have undertaken excessive credit allocation to environmentally destructive activities like fossil fuel extraction, and insufficient lending to green industries.

It is well within the capacity of central banks to do more to accelerate decarbonisation and change the rules of the game away from an extractive rent-seeking financial sector. We present several policies that the Bank of England could adopt, ranging from the adaptation of existing rules and schemes to bold new tools to address underlying problems in the system. Of course, central bank policy cannot take place in a vacuum, and must speak to the current institutional framework and wider context, including developments both in government policy and financial markets. Designing a climate-friendly central bank for the 21st century is fundamentally a political process. A substantial literature now exists on the financial and economic effects of climate change. It is time policymakers took this on board and envisaged a new mandate for the Bank of England to reflect it.

We start by looking at the big topic that is gaining traction: climate risk, and whether improvements to financial regulation can be the game changer for deflating the carbon bubble. Then we look at the central bank’s role in accelerating green investment. Finally, we turn to how wider issues are key to making sure a Green New Deal includes significant financial sector reform.