“Climate Bailout”: a new tool for central banks to limit the financial risk resulting from climate change

Abstract

To achieve the climate goals of the Paris Agreement, the bulk of identified fossil fuel resources cannot be burned and have to stay in the ground. This fact leads to a situation where a significant part of the fossil fuels already recorded in company balance sheets will become stranded assets in the near future. Since 2015, central banks have identified climate change as a large risk for financial stability, stranded assets constituting a significant element of this risk. To protect the economy from this risk, central banks need novel tools. The aim of this paper is to outline a new “climate bailout” tool which would enable fossil fuel industry actors, both in the Global North and Global South to sell their potentially stranded assets to central banks (mainly from the Global North) upon committing themselves to invest the received money into new and additional renewable energy (RE). Multilateral development banks and other development finance institutions would support this process, while central banks would take a new kind of long-term, low-yield green climate asset onto their balance sheets. The newly financed RE would substitute for lost fossil fuel energy supply and stabilise related prices. We demonstrate that a climate bailout would not only be in line with the general mandates of central banks, namely maintaining price stability and preserving the stability of the financial sector, but would also provide a new tool for central banks to counter fossil fuel price shock-induced inflation (fossilflation). We show how countries both from the Global South and the Global North could benefit from the implementation of this new financial tool.