Responding to Climate Change Through Proactive Prudential Supervision

Climate policy faces the challenge of dealing with pervasive and massive externalities compounded by crucial market failures. The price system, left to its own devices, is incapable of adequately dealing with this challenge and requires the support of appropriately crafted policy. However, this policy needs to be as pervasive as the climate challenge itself. Only one is effective and qualified for the job: finance policy.

In a policy brief, Daniel M. Schydlowsky argues for financial regulation in climate policy, arguing that financial regulation is efficient, effective, pertinent, appropriate and right for addressing climate change. Moreover, it is administered by trusted institutions. Some financial policy interventions provide finance directly while others promote such provision, protect from risk or prevent risk. The author explains that proactive prudential regulations (PPRs) fall mostly into the latter three categories, since they have a targeted objective and are designed to elicit behavior in the private sector. A well-designed set of PPRs oriented towards climate change can also be made to serve when a climate disaster strikes.

The policy brief concludes that financial regulations are particularly suited to dealing with climate externalities because they are both pervasive and similar in several other ways. There already exist regulations that could be used to further the purposes of climate policy. Furthermore, these regulations lie within the administrative discretion of the regulators and thus require no external approval, with the added benefit of being broadly accepted by the body politic given the standing of financial regulators. Finally, because they lie within the Regulator´s discretion, they can be rapidly applied and implemented.