Financial regulation, uncertainty and the transition to a net-zero-carbon economy

That climate change and the transition a net-zero carbon economy poses financial stability risks is now widely accepted by central banks. However, how financial authorities should measure, manage and act to ameliorate such 'climate-related financial risks' (CRFR) remains an open question. Very few regulatory interventions have been taken by central banks up until now despite the clear materiality of CRFR to their mandates. This chapter argues the roots of this absence of action lie with central banks' reluctance to move beyond 'market failure' conceptualisations of policy intervention from neoclassical welfare economics focused on information asymmetries and price discovery. Policies in this vein include disclosure of perceived climate risks, climate scenario analysis and stress tests. This approach is misguided as the net-zero transition involves systemic and endogenous forms of risk which make their quantification and efficient price discovery impossible. An alternative, precautionary policy approach is developed that seeks to ameliorate catastrophic and irreversible financial and economic losses and direct markets towards more sustainable forms of credit allocation. This draws on the 'precautionary principle' and post-crisis Inequality.