Every year, the Reserve Bank of India publishes a report on the state of currency and finance in India. It’s usually a very comprehensive overview of things such as how we can recover from the pandemic or how we’re handling inflation.

But this year, the RBI decided to surprise everyone with their theme — ‘Towards a Greener Cleaner India’. No prizes for guessing that it’s about climate change.

So in today’s Finshots, we decided to dive into the 190-page document* to figure out what the RBI thinks about the intersection of money and climate.

The Story

Glaciers are melting at a record pace in the European Alps. Pakistan witnessed record-breaking rains that affected 33 million people. This February was the hottest on record in India since 1901.

The RBI report starts with an alarmist note! But we all know about the devastating effects of climate change. We keep talking about it quite frequently at Finshots too.

But what can a central bank do to deal with all this?

To be honest, not much. Because most countries turn to fiscal measures to deal with climate change. Or put another way, decision-making is in the hands of the governments–local and central. It’s the government that can decide to impose some sort of carbon tax. Or they can give subsidies to companies engaging in renewable energy. Maybe even introduce ways in which companies can trade emission credits amongst themselves.

The central banks have no role to play in all of this. They’re just spectators. They can’t tweak interest rates or fiddle with monetary policy to fight climate change.

So why on earth are central banks worried about this phenomenon then?

You see, central banks have long had one mission — maintain price stability. Ensure that inflation doesn’t run rampant. And they’ve realized that climate change can hurt this objective. Extreme weather events can affect agricultural output. It can destroy productivity. It can tamper with people’s expectations of inflation. They might save more money and cut back on consumption. And all of this could lead to big variations in commodity prices.

It’s not just that.

Let’s assume that investors believe that India might be affected by climate change. They’ll think twice about investing in the country. They might even sell their assets. And when money leaves the country, it can affect the value of the Rupee and as a consequence affect our livelihoods.

So yeah, you can see why climate change is entering the central banking lexicon.

And what’s the RBI doing about this, you ask?

Well, not much at the moment. If you look at the report, only 20 pages actually talk about monetary policy and climate change.

There’s one part where they talk about trying to reduce dependence on cash.

However there is a section dedicated to cash and the emissions from printing, storing, and transporting physical currency. While it’s not quite quantified, we know it’s a lot. So the paper discusses the prospects of introducing a Central Bank Digital Currency (CBDC). It’s digital. There’s no printing. It’s easy to manage. In fact, they think that digital currencies could be more energy efficient than credit and debit cards. So it might well be the most ecological mode of payment.

Beyond this, they’ve also discussed how central banks could fiddle with policies that alter capital allocation.

For instance, RBI mandates commercial banks in India to push credit to what RBI calls ‘priority’ sectors. This typically includes agriculture, small businesses, education, housing etc. But a few years ago, the RBI decided to add the renewable energy sector within this ambit too. They wanted the sector to get the money it deserved.

And the paper thinks that maybe the RBI can create a new scheme that makes money available to banks at a low cost. Banks can then pass on this benefit to companies in the renewable energy space.

But that’s not all,  they could take things a bit further and actually reward banks that lend more to climate-friendly companies.

How can it do that, you ask?

See, there’s one cardinal rule in the banking industry. Banks are expected to set aside reserves in the event of emergencies. And central banks decide the kind of reserves banks are expected to maintain.

Now  the central bank of Lebanon decided to tweak this policy a bit to accord preferential treatment to some entities. If banks made loans to more environmentally friendly companies, they were allowed to get away with lower reserve requirements. So they wouldn’t have to set aside large sums of money. Instead they could use this money to create more loans and make even more money. This is a direct incentive to aid green companies.

Maybe the RBI could do something like that too.

But not everyone agrees that central banks should be taking up such matters of preferential credit.

Here’s one argument in The Economist:

“If it becomes normal for them [central banks] to tilt capital allocation in a desirable direction, why stop at climate change? The left would leap at the chance to penalise companies that are deemed too ruthless or which have pay structures that offend. Populists might want central banks to favour firms that invest at home and buy local. The more politicised central banks become, the less they would be perceived as independent authorities on economic policy.”

Either way, whether people like it or not, central banks are expanding their powers. There is a ‘mission creep’ underway as banks such as the European Central Bank and the Bank of England explicitly make climate change a key part of their monetary policy.

And more banks are joining the Network for Greening the Financial System (NGFS) — a group that gets together to talk climate change. In 2017, the group had 8 members — all central banks. Today, there are more than hundred banks. There is a tacit admission that there’s a link between climate change and financial instability and central banks are now trying to work together to see if they can do something about it.

Until then…

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*The document says that it isn’t an official stance taken by the RBI. It’s the views of the contributors.

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