Greening the UK Financial System

This policy note warns that the UK government’s 2019 Green Finance Strategy is over-reliant on transparency and disclosures, and lacks penalties for dirty activities. It also does not go far enough in addressing the financial market failures and systemic risks posed by climate change and the transition to a low-carbon economy.

The urgency of the climate crisis requires a “fit for purpose” approach to greening finance in the UK, the authors say. They go on to outline a comprehensive proposal covering institutional architecture, green monetary policy, banking regulation, and the decarbonisation of shadow banking and market-based finance.

The paper warns that a rapid low-carbon transition will not take place using a purely market-oriented approach. This is due to incompatible time horizons, greenwashing, corporate market power that opposes fundamental change, and other market failures. Instead it argues for using a more holistic, interventionist and precautionary approach.

The authors make a number of recommendations for this approach. The UK should develop a green and dirty public taxonomy, make climate-related disclosures mandatory based on such a public taxonomy, and set up a green finance action taskforce to oversee the greening of the financial system. The Bank of England should decarbonise its corporate bond purchases and collateral framework, and align risk-weighted capital adequacy rules with emissions criteria using the public taxonomy. Shadow banking and market based-finance can be decarbonised using green-supporting/dirty-penalising haircuts and margins, especially for globally systemic banks.

The authors recognise that fiscal, industrial and environmental policies have a larger role to play in rapidly reducing emissions. However, they show that the role of the BoE, and of supporting government and financial regulatory authorities, is critical in structurally realigning the UK’s financial sector with the challenges and risks posed by the climate crisis.