Overreacting to ex-ante perceived risks, whether credit or climate change related, is NOT in BoE’s remit.

Mark Carney, the Governor of the Bank of England, recently expressed some warnings on climate change, and specifically about the risks with “stranded fossil fuels”. 

I criticized that, considering the dangers that overreacting to perceived risks poses.

I got an official, very courteous and kind reply from the Public Enquiries Group of BoE. Unfortunately it is clear that they have not understood what I am referring to… it could be my fault... English is not my mother tongue.

And so here I will try to explain it again, briefly, with a reference to what is happening to banks.

Banks act on ex ante perceived credit risks, by means of setting risk premiums, the amounts of exposures and other contractual terms.

But bank regulators (Mark Carney is the current chair of the Financial Stability Board) decided to also act, on precisely the same ex ante perceived credit risks, by setting their capital requirements for banks.

And so we now have TWO bank reactions related to the same ex ante perceived credit risks. 

This results, of course, in that banks will hold more of assets perceived as “safe” than what those ex ante credit-risk perceptions would validate; and hold less of assets perceived as “risky”, than what those ex ante credit-risk perceptions would validate. 

In other words there is now a dangerous distortion in the allocation of bank credit to the real economy.

And I am sure that overreacting to ex-ante perceived risks, whether credit or climate change related, is NOT in BoE’s remit.

And I have seen no specific government policy approving of it. Would Winston Churchill have ever said: “We need twice the walls we need to keep out the ex ante risks we perceive"? Or, "We need to build one more Maginot Line on top of the other!"?

And so, back to my letter to BoE: The market is already worried, on its own, about “stranded fossils fuel assets” and so when big powerful BoE comes along and starts implicating that it also worries about those assets, and so it might conceivably do something about it, that again could provoke a dangerous overreaction to the ex ante perceived risks of stranded fossil fuels.

Do I make myself clearer now?

PS. When there is an overreaction then the only way ex ante perceived risks are correctly acted upon, is when these are adequately misperceived. That is how crazy all is.

PS. Of course, since climate change has much more long-term risk implications that are harder to clear for in the markets, allowing banks to hold less capital when financing sustainability, so that banks earn higher risk adjusted returns on equity when financing sustainability, could serve as a good stimulus that though distorting does so in the right direction.