Drawing inspiration from the concept of “black swan” events the term “green swan” is coined intentionally to associate climate-related risks with black swans, but also to juxtapose the two concepts. Black swans, defined as rare and unexpected events with extreme impacts that can only be explained after the fact, and green swans share many of the same features, such as, their occurrence is not reflected in past data and the possibility of extreme values cannot be ruled out. However, the key difference is that green swans can lead to irreversible impacts that will be difficult, if not impossible, to undo and green swans will materialise with a high degree of certainty.

Limitations of carbon pricing

Although carbon taxes are recognised as an essential step to fight climate change, carbon pricing has three limitations.

• Carbon pricing has been recognised as the best option for decades, yet governments have failed to act and will continue to do so without pressure from civil society and businesses.
• Carbon prices need to increase dramatically in a very short time period to reduce the risk of reaching irreversible tipping points; however, doing so may trigger “transition risk”, threatening financial stability in the short-term.
• Avoiding climate change related market failure requires prioritising long-term ethical choices over short term gains and high carbon prices alone may not be enough to change individual behaviours.

Climate change as a threat to financial and monetary stability

Climate-related risks are threatening socioeconomic activities, thereby affecting the ability of central banks to fulfill their mandates of monetary and financial stability. The threats to monetary and financial stability are characterised by the following:

Climate-related risks as a source of monetary instability

• Supply and demand shocks may pull inflation and output in opposite directions, and generate a trade-off for central banks between stabilising inflation and output fluctuations with implications on the long-run level of the real interest rate.

Climate-related risks as a source of financial instability

• Physical Risks: arise from the interaction of climate-related hazards with the vulnerability of exposure to human systems and the economic costs and financial losses due to increasing frequency and severity of climate-related events.
• Transition Risks: financial impacts resulting from a rapid low-carbon transition, including policy changes, reputational impacts, technological breakthroughs, and shifts in market preferences and social norms.

Challenges with current methodologies and traditional risk assessment models

While having an application in traditional risk assessments, backward-looking models that extrapolate historical trends prevent full appreciation of the future systemic risk posed by climate change. Climate change-related risks represent methodological challenges such as the inability of macroeconomic and climate scenarios to capture a large range of climate.

Role of central banks in contributing to coordination to combat climate change

• Promote long-termism by supporting principles of sustainable finance.
• Call for an increased role for fiscal policy in support of the ecological transition.
• Increase cooperation on ecological issues among international monetary and financial authorities.
• Support initiatives promoting greater integration of climate and sustainability dimensions within corporate and national accounting frameworks.

1. “Green Swan” events could be the cause of the next systemic financial crisis and have a significant, if not permanent, impact on economic output. If no action is taken to reduce carbon emissions, a quarter of global GDP could be lost.
2. Central banks have increasingly recognised that climate change is a source of major systemic financial risks. In the absence of well-coordinated and ambitious climate policies, there is a growing awareness that physical and transition risks would affect the stability of the financial sector. A new global financial crisis triggered by climate change would render central banks and financial supervisors powerless.
3. Transdisciplinary approaches are needed to capture the multiple dimensions (eg geopolitical, cultural, technological and regulatory ones) that should be mobilised to guarantee the transition to a low-carbon socio-technical system. Approaches include: exploring new policy mixes (fiscal-monetary-prudential) that can better address the climate imperatives ahead and that should ultimately lead to societal debates regarding their desirability, considering climate stability as a global public good to be supported through measures and reforms in the international monetary and financial system, and integrating sustainability into accounting frameworks at the corporate and national level.
4. Five ways climate-related risk can materialise into financial risks and threaten central bank mandates: credit risk, market risk, liquidity risk, operational risk and insurance risk.
   
5. Despite growing pressures that may force central banks to intervene as “climate rescuers of last resort”, central banks cannot replace governments or the private sector to make up for insufficient action.
   
   
6. Methodological challenges related to measuring climate-related risks include the inability of macroeconomic and climate scenarios to holistically capture a large range of climate, social and economic factors. Their translation into corporate metrics within a dynamic economic environment and the difficulty of matching the identification of a climate-related risk with the adequate mitigation action.
   
7. Central banks and supervisors could explore different approaches that can better account for the uncertain and nonlinear features of climate-related risks by working with non-equilibrium models, conducting sensitivity analyses and conducting case studies focusing on specific risks and/or transmission channels. However, approaches remain limited by the sources of deep and radical uncertainty related to climate change.
8. Central banks must be more proactive in calling for broader and coordinated change, in order to continue fulfilling their own mandates of financial and price stability over longer time horizons than those traditionally considered. Contributing to this coordinating role is not incompatible with central banks, regulators and supervisors doing their own part within their current mandates.
9. Central banks may inevitably be led into uncharted waters in the age of climate change. If they wait for other government agencies to jump into action, central banks could be exposed to the real risk of not being able to deliver on their mandates of financial and price stability.