In recent years, climate change has transcended its conventional status as merely an environmental or social issue and firmly established itself within the realm of global financial stability. Central banks, traditionally viewed as the guardians of monetary policy and economic equilibrium, are increasingly confronted with the intricate challenges posed by climate and transition risks. These risks, if inadequately addressed, have the potential to destabilize financial systems, impede economic growth, and exacerbate the socio-economic disparities emerging from the global transition to a low-carbon economy. In the article “How central banks address climate and transition risks,” Shears, Meckling, and Finnegan delve into the evolving role of central banks in mitigating these multifaceted threats, laying out a framework that blends economic foresight with environmental stewardship.
At its core, climate risk manifests in two primary dimensions: physical risks and transition risks. Physical risks stem from the direct impacts of climate change, such as increased frequency and intensity of extreme weather events, rising sea levels, and chronic shifts in climate patterns. These events threaten the solvency of institutions by undermining asset values, disrupting supply chains, and fomenting systemic shocks. Transition risks, on the other hand, arise from the societal, technological, and policy shifts required to mitigate climate change. This includes regulatory reforms, shifts in consumer preferences, and rapid technological advancements that could render entire sectors or assets obsolete. For central banks, comprehending and integrating these complex risk profiles into monetary policy and financial oversight represents a profound paradigm shift.
Central banks have historically centered their mandates around price stability and employment. However, the introduction of climate change into their strategic considerations marks a significant evolution. By recognizing climate and transition risks as potential sources of financial instability, central banks are compelled to innovate and adapt traditional regulatory and supervisory frameworks. This includes reassessing risk exposure in banking portfolios, redefining collateral frameworks, and reimagining stress testing methodologies to incorporate climate scenarios that extend beyond the standard economic cycles. The adaptation signals a proactive effort to safeguard not only financial markets but also the broader economy’s resilience.
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One of the most challenging aspects for central banks is the quantification and integration of climate risks into existing financial models. Traditional risk assessment tools largely rely on historical data and relatively stable economic variables. Climate-related risks, conversely, are characterized by uncertainty, long time horizons, and a high degree of complexity. This necessitates the development of forward-looking modeling techniques that combine climate science with financial analytics. Central banks are increasingly leveraging scenario analysis and climate stress testing to gauge potential impacts under various emissions trajectories and policy pathways. Such techniques enable institutions to anticipate vulnerabilities and adjust capital buffers accordingly.
Moreover, the interconnectedness of global financial markets demands coordinated action to address climate risks consistently across jurisdictions. Central banks face the dual challenge of harmonizing their approaches while accommodating diverse economic structures and climate vulnerabilities. International bodies such as the Network for Greening the Financial System (NGFS) play a pivotal role in fostering collaboration, sharing best practices, and standardizing methodologies. This collaborative approach is critical to prevent regulatory arbitrage, which could undermine efforts to mitigate systemic risks posed by climate change.
A core instrument through which central banks influence the climate agenda is monetary policy. While monetary policy is conventionally aimed at controlling inflation and supporting economic growth, its tools have untapped potential to drive the transition towards sustainable finance. For instance, central banks can recalibrate asset purchase programs to favor green bonds and climate-aligned investments, thereby reducing the cost of capital for sustainable projects. Additionally, collateral frameworks can be adjusted to reflect the climate risk profiles of different asset classes, incentivizing firms to enhance their environmental performance. This integration of climate considerations into monetary policy represents an innovative frontier in central banking.
The regulatory and supervisory roles of central banks also afford substantial influence in shaping corporate behavior. By embedding climate risk disclosure expectations within supervisory frameworks, banks are pushed towards greater transparency and enhanced risk management. The development and enforcement of standardized disclosure requirements, aligned with frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), ensures that market participants have access to reliable, comparable climate information. Effective supervision compels financial institutions to internalize climate risks, mitigating the potential for sudden market corrections triggered by unforeseen environmental exposures.
The challenges do not end with the financial sector’s adaptation. Central banks must also account for the macroeconomic repercussions of the green transition. Structural shifts such as devaluation of fossil fuel-dependent assets, labor market transitions, and changing consumption patterns impose complex trade-offs that monetary policy must navigate. Balancing short-term economic stability with long-term sustainability goals demands nuanced policy design and a radical rethinking of economic models. Furthermore, there is a critical need to ensure that climate policies do not exacerbate socio-economic inequities, preserving inclusive growth during this profound transformation.
Capacity building and knowledge exchange emerge as essential components of this new central banking mandate. The interdisciplinary nature of climate risks demands expertise spanning finance, environmental science, economics, and policy analysis. Central banks are investing in specialized teams, forging partnerships with academic institutions, and engaging with the private sector to enhance their analytical capabilities. Enhancing staff expertise ensures that climate risk is not an abstract concept but a concrete factor in policy formulation and execution.
Data quality and availability stand as prominent obstacles in climate risk management. The fragmented nature of climate data, coupled with inconsistencies in reporting standards, impairs accurate risk assessment. Central banks are championing efforts to improve data infrastructure, advocating for comprehensive and timely disclosure, and integrating non-traditional data sources such as satellite and sensor data. Enhanced data ecosystems empower regulators and market participants to make informed decisions, elevate market discipline, and foster a more resilient financial architecture.
The integration of climate considerations within central banking also has far-reaching implications for market dynamics and innovation. By signaling the inevitability of green transitions, central banks exert influence over investment flows, encouraging the proliferation of sustainable finance instruments. This incentivization stimulates innovation in green technology and infrastructure financing, catalyzing broader economic transformation. As central banks underscore the financial materiality of climate risks, they contribute to the mainstreaming of environmental sustainability in capital markets.
However, the path forward is fraught with uncertainty and debate. Questions surrounding the scope of central banks’ mandates, the potential politicization of monetary policy, and the balancing act between climate goals and traditional economic objectives persist. Critics caution against overextension into policy domains traditionally reserved for elected bodies, while proponents argue that ignoring climate risks jeopardizes financial stability. Navigating these tensions requires transparent governance, clear communication, and robust accountability mechanisms within central banks.
Looking ahead, the evolution of central banking in response to climate and transition risks is poised to shape the trajectory of global financial stability and sustainable development. Embedding climate-aware risk management, refining regulatory tools, fostering international cooperation, and enhancing technical expertise form the pillars of this transformative agenda. As climate science advances and policy landscapes evolve, central banks will need to maintain agility, innovation, and strategic vision to fulfill their expanded role effectively.
In summary, Shears, Meckling, and Finnegan articulate a comprehensive assessment of the challenges and opportunities that lie at the intersection of central banking and climate governance. Their work underscores the imperative for central banks to embrace climate and transition risks as integral to their core functions. Through adaptive policies, enhanced risk management frameworks, and collaborative governance, central banks can play a pivotal role in steering economies towards a more resilient and sustainable future.
Strong institutional commitment, continuous innovation, and rigorous integration of climate considerations will enable central banks to navigate the uncharted waters of the green transition. As they champion financial stability amidst unprecedented environmental challenges, their leadership will be instrumental in shaping not only economic outcomes but also the broader societal response to one of the defining issues of our time.
Subject of Research: How central banks are addressing climate and transition risks in financial systems.
Article Title: How central banks address climate and transition risks.
Article References:
Shears, E., Meckling, J. & Finnegan, J.J. How central banks address climate and transition risks.
Nat Energy 10, 431–432 (2025). https://doi.org/10.1038/s41560-025-01725-9
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