The Central Bank and Sustainability - Governor Philip R. Lane

Speech to the CEO Breakfast Forum at Business in the Community Ireland 

Good morning. I would like to thank Business in the Community Ireland (BITCI) for inviting me to address the Annual CEO Breakfast Forum.

I want to commend BITCI for the work it is doing to promote corporate social responsibility (CSR) and sustainability.  At the Central Bank, we have benefited from the guidance of BITCI in developing and enhancing our own CSR and sustainability activities.

I also wish to congratulate in advance the companies that will be awarded here today with the Business Working Responsibly mark. Based on a comprehensive set of criteria, this independent accreditation signals strong commitment to CSR and sustainability.  The Central Bank intends to apply for this mark in 2018.

Today, I wish to provide the Central Bank’s perspective on sustainability from two angles. First, I will report on our own efforts to act as a socially-responsible and sustainable institution. Second, I will discuss the interaction between the financial system and sustainability from the perspective of financial regulation and financial stability policies.

The Central Bank’s Commitment to Sustainability

I want to begin by underscoring the importance for institutions of sustainability and acting as responsible, trusted employers.  BITCI is Ireland’s network for socially-responsible businesses and this morning’s event provides an opportunity to learn from each other in relation to best practices.

As the regulator of over 10,000 financial service providers in Ireland, it is especially important that the Central Bank plays its part in the sustainability agenda. As such, allow me to highlight briefly our work in fostering socially-responsible and sustainable policies and work practices.

The move to our new headquarters in North Wall Quay, which received the Royal Institute of Architects of Ireland Universal Design award in July, provided an opportunity to develop a sustainable, environmentally-friendly building and improve the way we worked within it. Our goal is to be a fulfilling workplace where staff are encouraged to regularly meet and collaborate, assisted by open and accessible working places.

On the environmental front, this year we switched over to 100 per cent green, renewable energy and our new building is also set to achieve a formal building energy rating (BER) of A2,  which is exceptionally high for a building of this size and use. The original design for the building was a C3 rating, so our design should require 70 percent less energy by comparison.  This supports the Bank’s commitment to achieving an energy saving target of 33 per cent by 2020, as set out in the National Energy Efficiency Action Plan for the Public Sector.

The move to our Dockland Campus, ongoing initiatives at our Currency Centre in Sandyford and some key design features in the North Wall Quay building should help us achieve this reduction ahead of the 2020 target.  Just some of the ways we are doing this includes rain-water harvesting for external cleaning and landscaping and introducing mobile technologies for staff enabling not only more flexibility, but also contributing to a 24 per cent decline in printing volumes.  We have also developed an online catalogue of our extensive public archives, having recently opened them to the public, allowing people to search online and identify what they would like to consult.

We constantly strive to improve the trust and understanding of the public we serve. To that end, our new headquarters also includes a brand new Visitor Centre, open Monday to Friday from 10am to 4pm, should you care to visit. Alternatively, many of our most popular exhibitions can be found on tour at the National Ploughing Championships as we continue to find new ways of proactively taking our message out to the public. Our new building was also opened to the public through the Culture Night and Open House initiatives.

Our new offices have been designed to allow ease of access for all staff and visitors. Facilities now include accessible entrances, well-designed lifts catering for people with hearing and visual impairments, easy to open doors, signage with embossed lettering, hearing enhancements provided at key locations, bathrooms designed to cater for everyone's needs and well-designed open plan areas to allow ease of movement throughout the building.

Governance

In recent years, we have taken a number of steps to formalise our commitments to CSR and sustainability, publishing policy and performance data on our website, which the Commission of the Central Bank reviews and approves on an annual basis.   We work to appropriate ISO and OHSAS standards to ensure that the way we work is continually improving our performance and efficiency.  We are now working to achieve an “Excellent” rating in BREEAM in-use, which measures the Banks operational efficiency within the new building. ¹

Diversity and Inclusion

As our own Deputy Governor Ed Sibley, who leads our Diversity and Inclusion Steering Group mentioned in a speech just this week, that diversity is increasingly seen as a competitive differentiator; specifically, that when companies embrace gender and ethnic diversity at the leadership level, they are more likely to be successful.²

McKinsey’s research in this area suggests that companies in the top quartile for gender or racial and ethnic diversity are more likely to have financial returns above their national industry medians.³

More broadly, the Central Bank is also active in the external community.  Our staff-led Charity Committee raises funds and provides supports for our selected partner charities. We also are engaged with a number of outreach activities with local community groups, while staff members volunteer with the Early Learning Initiative (ELI) that supports local schools.  In addition, around thirty staff members volunteer in over twenty schools through Junior Achievement Ireland (JAI).

All of this work is vital to recruiting and retaining the staff required to safeguard financial stability and protecting consumers. We know that potential employees, especially but not exclusively millennials, place increasing importance upon how an organisation demonstrates that it is an ethical and sustainable employer.

Indeed, the Business Working Responsibly mark is a key indicator of best practice in this area, and one that is likely to be coveted at a governance level as firms seek to recruit the best.  For the Central Bank, these elements are essential if we wish to stand ready to safeguard the financial system of tomorrow.

Sustainability: A Macro-Financial Perspective

Let me now turn to addressing sustainability from a macro-financial perspective. While a “bottom up” sustainability philosophy is essential with each household and each institution (in both the private and public sectors) playing its part in promoting sustainability, it must be complemented with a macro-level strategy that fully incorporates the feedback loops between policies (both domestic and international) and system-wide sustainability.

In this section, I wish to address two issues.  First, I will explain how the Central Bank’s financial stability mandate contributes to long-term sustainability.  Second, I will turn to the implications of sustainable environmental policies for the financial system.

It is important to understand that macro-financial stability is a necessary pre-condition for the implementation of such a strategic policy framework.  At both domestic and international levels, this basic lesson has been painfully illustrated by the boom-bust credit cycle during 2003-2009, the European sovereign debt crisis during 2010-2012 and extended post-crisis recovery dynamics that has dominated the European policy agenda in recent years.

During phases of macro-financial instability, there are several barriers to making progress on the sustainability agenda.  First, elevated uncertainty about future growth prospects induces both public and private decision makers to delay investment plans.  Second, the fiscal costs of financial crises divert resources that would otherwise be available to address long-term policy targets.  Third, the bandwidth of the political system is absorbed by crisis management, with longer-term policy questions deferred to the indefinite future. Fourth, boom-bust investment cycles are wasteful of precious resources.  To take an obvious example, the history of the construction sector in Ireland over the last fifteen years provides a basic case study of how untamed credit can contribute to severe mis-allocation of resources, across time and across geographies.

Accordingly, there is a strong coherence between the policy mandate of the Central Bank to pursue financial stability and the long-term sustainability agenda.⁴ We promote financial stability through both micro-prudential and macro-prudential policies.  The former refers to the regulations that set minimum capital and liquidity ratios for individual financial institutions, supported by an engaged programme of supervision and inspections.⁵  The latter refers to additional capital buffers and risk weights that can be imposed in recognition of systemic risk factors, together with borrower-based measures such as ceilings on loan-to-value (LTV) and loan-to-income (LTI) ratios to address the systemic risks that can be generated by collective overborrowing by households.

The capital ratios set by the Central Bank include an additional buffer for each systemically-important institution (the so-called O-SII buffer).⁶    In addition, we can activate a counter-cyclical capital buffer (CCyB) by raising the minimum capital ratio for banks during periods of above-normal credit growth and lowering it during periods of below-normal credit growth. This both increases the resilience of banks to unexpected reversals in credit dynamics and could also act to dampen credit cycles and increase both the sustainability of lending and the stability of financial institutions.

At this time, while new lending is picking up, our assessment is that the credit cycle remains subdued so the counter-cyclical capital buffer is set at zero. But we review the buffer on a quarterly basis, so this is a policy tool that can be used to respond quickly to cyclical shifts in credit conditions.  A small but increasing number of EU countries have raised the counter-cyclical capital buffer in recent times.

Finally, financial stability is also underpinned by the recovery and resolution regimes that have been introduced to make it easier to deal with distressed institutions.   The Central Bank is Ireland’s national resolution authority, working in cooperation with the Brussels-based Single Resolution Board (SRB) for larger institutions.

Let me now turn to the implications of environmental sustainability for the financial system. At a general level, a basic function of the financial system is to allocate resources to expanding sectors and withdraw resources from contracting sectors.  This is easiest if structural change unfolds at a gradual pace, allowing natural adjustment mechanisms to facilitate the decline of unsustainable activities and the growth of sustainability-enhancing activities.  However, if there is a sudden shift in economic and financial structures, this is much more disruptive in terms of the capacity of the financial system to absorb losses on loans and investments in entities that require restructuring or outright bankruptcy.

These considerations are relevant in assessing the implications for the world financial system of adapting to lower carbon intensity.⁷    A gradual transition is feasible, if there are sufficient early policy interventions to set the world economy on a clear path towards a sustainable future.  Alternatively, if adjustment is delayed, there is an elevated risk of a sudden and disruptive shift in carbon intensity.  This would have adverse consequences for the financial system not only through direct exposures to carbon-intensive firms and industries but also through the broader recessionary impact of a sudden shift in demand patterns and potential output.

This risk factor lies behind the support of the Financial Stability Board (FSB) for the Taskforce on Climate-related Financial Disclosures (TCFD), which released its final set of recommendations in June 2017.⁸   It is essential for firms to make consistent, climate-related financial risk disclosures if financial institutions are to assess credit and investor risks on an adequate basis and if regulators are to capture properly the systemic risks associated with carbon exposures.  As underlined by the global role of the FSB in driving forward the disclosures agenda and climate-related research published by the Bank of England, the European Systemic Risk Board and other financial regulators, the international financial regulatory community is actively preparing for the carbon transition.

Such disclosures are also important in guiding the asset allocation decisions of investors that wish to protect against climate risks or simply pro-actively favour pro-sustainability firms.  The rise of the Environmental, Social and Governance (ESG) asset class underlines the increasing priority attached by many market participants to rewarding the sustainability and ethical impact of firms seeking investor support.

Conclusions

Sustainability is to the forefront of the global long-term policy agenda.  At the Central Bank, we are clear on our responsibilities.  First, as an institution, we must act in a socially-responsible and sustainable manner.  Second, our work to maintain financial stability is a necessary pre-condition for the successful pursuit of long-term sustainability policies.  Third, we must ensure that the financial system is adaptable and resilient in order to manage the carbon transition.   In partnership with the international regulatory community, this agenda will drive our work in the coming years.

Acknowledgements: I thank Mary Canniffe and David Naylor for their assistance in preparing this speech.

¹ We are targeting this rating for 2019, since the accumulation of two years of data are required to validate performance.

² Ed Sibley (2017), “Is it legal? A Question of Culture”, speech, Eversheds Sutherland Conference, November 14. Available on Central Bank website.

³ Hunt, V., Layton, D., and Prince, S., Why diversity matters, McKinsey & Company, January 2015. Available here.

⁴ Macro-financial stability is also supported by a counter-cyclical, resilient fiscal strategy. For more details, see Philip R. Lane (2017) “Macro-Financial Risk Management”, speech, Central Bank of Ireland Economic Roundtable, 8 September. Available on Central Bank website

⁵ Since November 2014, the micro-prudential regulation and supervision of banks is within the framework of the ECB’s Single Supervisory Mechanism (SSM), which directly supervises the largest banks in Europe, including the main Irish banks.

⁶ The acronym O-SII stands for Other Systemically Important Institutions.

⁷ For more details, see “Too Late, Too Sudden: Transition to a Low-Carbon Economy and Systemic Risk,” Report No. 6 of the Advisory Scientific Committee, European Systemic Risk Board, 2016.

⁸ For future details on the work of the TCFD, see: www.fsb-tcfd.org.