“Tis new to thee’: response to Gruenewald, Knijp, Schoenmaker, and van Tilburg

Abstract

In ‘Embracing the Brave New World: A Response to Demekas and Grippa’, a response to our article ‘Walking a Tightrope: Financial Regulation, Climate Change, and the Transition to a Low-Carbon Economy’, both published in the Journal of Financial Regulation, Gruenewald, Knijp, Schoenmaker, and van Tilburg claim that climate risk is a clear and present danger to financial stability that justifies imposing higher capital requirements on supervised firms. Until the current prudential risk framework is revised to fully capture climate risk, they advocate ad hoc measures, such as adjustments to risk weights, which, they believe, would have the desired effect. In this article, we argue that these claims are misguided. Given the nature of climate risk, risk assessment models cannot provide a reliable basis for calibrating capital requirements. On the basis of the evidence, prudential tools would have only a negligible impact on the transition. And the idea of adjusting risk weights for climate exposures has been abandoned—for good reasons. Ultimately, there is nothing financial regulation can do about the energy transition that an appropriately designed carbon tax cannot do better. Central banks and financial regulators should resist the pressure to take on additional responsibilities that are essentially political and that they cannot properly discharge.