How Can Central Banks Accelerate the Green Transition?

As climate change emerges as a systemic financial risk, central banks are stepping beyond their traditional roles to support the transition to a low-carbon economy. Through monetary policy, supervision, and strategic communication, they are reshaping capital allocation by making high-emission activities more costly and green investments more attractive.

“Stop funding climate killers”. This is what was written by Greenpeace on a sign, put on the European Central Bank building in March 2021. The message targeted a powerful but often overlooked actor: central banks. Once seen as neutral technocratic institutions, they are now increasingly drawn into the fight against climate change, as global warming emerges as a systemic threat to financial and economic stability.

Central banks are increasingly seen as potential actors in the transition toward a low-carbon economy. In the same time, Climate change is increasingly recognized not only as an environmental challenge but also as a systemic macro-financial risk. As its economic and financial consequences intensify, the issue has moved into the realm of central bank responsibilities, whose mandates traditionally focus on maintaining price stability and safeguarding financial stability. The impacts of climate change are transmitted to the economy through multiple channels. On the one hand, physical risks – such as extreme weather events, rising temperatures, and natural disasters- can disrupt production, damage infrastructure and generate volatility in food and energy prices. On the other hand, transition risks arising from climate policies, technological shifts, and changes in market preferences can affect asset valuations, investment patterns and the structure of entire industries.

Central Banks Steering Capital

Together, these risks have direct and indirect implications for inflation dynamics, economic growth, and the resilience of the financial system. As a result, climate change is viewed as a factor capable of shaping macroeconomic conditions and financial stability. This growing recognition has led financial regulators and more precisely central banks to increasingly integrate climate-related risks into their analytical frameworks, policy discussions, and supervisory practices.

Beyond their traditional policy tools, central banks can influence financial conditions in ways that affect that allocation of capital across sectors. In particular, adjustments to central bank collateral frameworks and asset purchases programmes can be designed to favour environmentally sustainable assets. By granting more favourable treatment to green securities or by increasing their presence in central bank portfolios, monetary authorities can indirectly channel financing toward greener activities.

Such measures can alter relative financing conditions across firms; by lifting operations towards low-carbon assets, central banks may reduce borrowing costs for environmentally sustainable firms while making financing relatively more expensive for companies with high carbon emissions.

This mechanism affects the incentives faced by firm and investors, encouraging capital to move away from carbon-intensive activities and toward greener investments. Through these channels, monetary policy operations can therefore play a supporting role in shaping investment decisions and facilitating the broader green transition.

Central banks also play a crucial role in addressing climate-related risks through their supervisory responsibilities. As regulators of the banking system, they can encourage commercial banks to better identify, measure, disclose, and manage exposures to climate risks. Tools such as climate-related supervisory guidance and stress tests allow authorities to assess how banks would respond under different scenarios. By integrating these risks into prudential supervision, central banks can incentivize financial institutions to adjust their risk management practices and portfolio composition. In practice, this may lead banks to gradually reduce lending to highly carbon-intensive firms, which are more exposed to transition risks and potential future losses.

Is Communication the New Key Factor in Central Bank’s Climate Strategy?

Another important channel through which central banks can and do influence the green transition is communication.

Central bank actions and signals influence the allocation of investment across the economy through expectations. When the European Central Bank (ECB) signals a stronger commitment to climate-related policies, financial markets revise their expectations about the future profitability and risks of carbon-intensive activities. These signals increase the perceived risk associated with “brown” firms, leading investors to demand higher returns for holding their assets. As a result, the cost of capital for carbon-intensive companies rises, making it more difficult and expensive for them to finance new projects.

At the same time, firms that are better aligned with the low-carbon transition benefit from improved financing conditions. Lower borrowing costs and greater investor interest facilitate green investment and innovation. This divergence in financing conditions gradually redirects capital toward more sustainable activities, reinforcing incentives for firms to adapt their business models.

This reallocation mechanism relies crucially on how central banks communicate their policy intentions, as not all communication has the same impact. Jourde et al. (2026) show that markets clearly distinguish between communication that simply highlights climate risks (“materiality” communication) and communication that signals actual policy actions. Communication becomes particularly powerful when it signals concrete measures, such as the introduction of green stress tests or the intention to reduce purchases of carbon-intensive assets.

A sustainable effect

When the ECB communicates credible policy actions, high-emission firms systematically underperform, both in equity and credit markets, reflecting a reassessment of transition risk. This effect is immediate and persistent, indicating that markets price in these signals as forward-looking policy shocks rather than temporary news.

As a result, the ECB climate communication operates as a “green put”: by signalling a tightening of future climate-related policies, it increases the perceived risk of carbon-intensive assets and raises their cost of capital. Over time, this mechanism has significantly reduced the so-called “brown premium” – by around 30% – by preventing high-emission firms from achieving the excess returns predicted by standard asset pricing theory.

Through these market responses, central bank signals and policy frameworks can contribute to a progressive reallocation of investment in favour of the green transition.