Greening Collateral Frameworks

This paper from the Inspire research network argues that central banks should adjust their collateral frameworks based on the environmental impacts of the assets put forward.

It draws a distinction between this “environmental footprint approach” and a “risk exposure approach”. In the latter case, credit assessments used in collateral frameworks are modified to better capture climate-related risks.

The authors’ preferred method could see higher haircuts applied to the securities of companies that are misaligned with the Paris Agreement targets, potentially raising the cost of borrowing for those firms. Such securities could also be deemed ineligible for use as collateral altogether.

The paper highlights research showing that central banks’ existing collateral frameworks suffer from a carbon bias, in that they disproportionately favour better financing conditions for carbon-intensive activities.

The report suggests that an explicit focus on environmental impact would contribute directly to the decarbonisation of the financial system. It argues that it would also avoid certain practical challenges involved in targeting risks, such as a reliance on imperfect data. It would also avoid penalising companies exposed to physical risks.

The paper notes that the European Central Bank has said it will use the environmental risk approach for greening the Eurosystem collateral framework, although it has included sustainability-linked bonds in the list of assets accepted as collateral. The People’s Bank of China has also added green bonds to its list of eligible assets.