Proposals

#4 Promote fair and sustainable lending by banks

The powers of banks to create money by making loans to households and businesses is a hugely important tool for the economy. If banks do not lend enough money to the economy this usually causes a recession (economists call this phenomenon a “credit crunch”). But if banks lend too much money, especially in certain sectors like housing, this may create asset bubbles and financial crises.

Since the financial crisis, the European Central Bank (ECB) supports credit creation by refinancing banks at negative interest rates. Practically speaking, this means that banks actually earn money when they borrow from the ECB. The ECB does this to stimulate lending by banks and thereby stimulate the economy.

At the moment, the ECB provides money to commercial banks regardless of the environmental impact of the activities they finance. Commercial banks make autonomous decisions about how to allocate credit. Whether they lend to fossil fuels projects or green projects, the ECB doesn’t care much.

It is also questionable whether the ECB’s strategy is fair. Even with currently low interest, most low-income households are not eligible to get bank loans. This can be contrasted to those who are already asset-rich and can acquire more stakes in the economy by for example borrowing money to purchase more housing lots to rent out. Studies show that access to housing ownership has become harder for younger generations as well.

It is time for the ECB to look at the quality of the lending that banks generate thanks to its policies. An alternative would be for the ECB to create incentives for banks to finance green activities, for example by offering even lower interest rates to banks when they finance SMEs that want to create zero-waste solutions, farmers who want to shift to more sustainable practices, homeowners who want to install solar panels on their roof to minimize their environmental footprint and their energy bills, and the list goes on.

Adjustments could be made to the ECB’s existing lending tools, such as its Targeted Longer-Term Refinancing Operations (TLTROs) programme, so that more money could be unlocked for sustainable investments and a green recovery from the Covid-19 crisis.

Another alternative would be to promote publicly-owned banking or “stakeholder’s banking” models. In these models,  the bank’s lending strategies are decided by government or civil society and social partners and not only private shareholders who are in it just for the profits. If banks were run by a mix of social partners, local governments and businesses, there is a chance that lending by banks would be better guided towards projects that benefit the whole society.

➕ Pros

• By promoting green lending, the ECB is helping to meet its mandate — keeping the economy stable — in that it is actively tackling the risks arising from climate change.
• The ECB could make it more expensive for banks to borrow money from it if they lend to companies or individuals regardless of their environmental footprint.
• It would send a clear message that the ECB is committed to tackling climate change using all of its policy tools.
• More money could be unlocked for the green transition particularly for SMEs and individuals.
• Better allocation of credit would create more jobs and reduce inequality.

➖ Cons

• It’s primarily the role of governments to penalize the negative climate impact of companies.
• Giving additional objectives to the ECB risks overburdening the banks and creating too much expectations.
• It would subject the ECB to the criticism that it is drifting away from its primary mandate of ensuring price stability. This could make it vulnerable to legal challenges.
• This would be contrary to the principle of market neutrality which is dominant today i.e. the ECB can not favor any specific company or sector when carrying out its programmes.