BoJ admits operations are subject to carbon bias

The Bank of Japan (BoJ) is taking steps to correct a potential carbon bias in its market operations, a top official said yesterday. However, critics claim its actions are inadequate since it does not apply strict environmental standards across all of its lending and investments.

Deputy governor Masayoshi Amamiya said that if financing decisions in the private sector are made without taking the negative externalities of greenhouse gases into account, apparently “market neutral” actions will preserve a resource allocation that is biased toward dirty industries, compared to what is socially desirable.

He highlighted the BoJ’s green lending scheme as an example of its efforts to address this problem. The facility, launched at the end of last year, provides zero-interest financing towards loans and investments for sustainable projects.

The BoJ requires participating financial institutions to use the funds to issue green or sustainability-linked loans and bonds, and to provide transition finance. They must show that the activities they are supporting comply with relevant national and international standards, such as the International Capital Market Association guidelines on green bonds.

Experts have questioned the credibility of such guidelines, pointing out that bonds and loans issued under them do little to address a company’s wider environmental impact. They can also allow high-carbon firms to claim green credentials without fundamentally changing their business models.

Writing for Green Central Banking, former BoJ board member Sayuri Shirai warned that the lack of a domestic green taxonomy means it is unclear how activities financed under the scheme are contributing towards Japan’s legally-binding carbon neutrality target.

Moreover, the BoJ has not yet applied the same logic to its other market activities, such as the purchase and ongoing reinvestment of corporate bonds, commercial papers and stock exchange-traded funds. Its failure to exclude fossil fuel assets from its asset purchases and collateral framework was cited as a hindrance to its performance in the latest Green Central Banking Scorecard.

The BoJ’s lack of progress in decarbonising other aspects of its monetary policies sets it apart from the European Central Bank, which is beginning to exclude companies with poor climate performances from its asset purchase programme, and will apply higher haircuts to bonds issued by polluting companies in its collateral framework.

In the absence of more interventionist measures, the BoJ appears to be relying on market discipline to improve companies’ behaviour. Amamiya said that participation in the climate loans scheme had prompted financial institutions to “enter a dialogue” with customers about their efforts to reduce carbon emissions, adding that the bank hoped the operations would work as a catalyst towards decarbonising Japan’s economy.

Amamiya revealed that the BoJ will conduct further surveys of financial institutions, companies and rating agencies to assess the functioning of climate change-related markets. He said an initial survey in August showed strong demand for green bonds and other environmental, social and governance-linked debt instruments. But he added that some potential investors and issuers are put off by lack of information and uncertainty about how to measure climate risks.

He also mentioned the results of the BoJ’s pilot scenario analysis exercise, conducted with six large banks and insurers earlier this year. He said the BoJ is working with financial institutions to develop the sophistication of such exercises, but gave no details as to if and when the it might lead a further iteration of the initiative.