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Central banks, the most powerful financial institutions in the world, want to become the guardians of the environment as well.

The central banks say climate change is a financial and economic risk. They believe rising sea levels, more wildfires and bigger storms could cause shortages that spur inflation, the regulators’ traditional nemesis.

The banks that are deepest into the issue are trying to limit climate change by steering their financial systems away from fossil fuels. Their regulations could hit U.S. companies operating overseas. The Bank of England’s remit now explicitly includes environmental sustainability as well as maintaining price stability.

The Federal Reserve is proceeding cautiously, worried about financial risks but wary of expanding its mandate, which would put it in the middle of the partisan debate over climate change.

In December, the Fed joined the Central Banks and Supervisors Network for Greening the Financial System. That group, which includes central banks and regulators of major European countries as well as China, Russia and Japan, started with eight members in 2017.

Now, with 90 central banks and regulators as members, the group is planning to meet at a major conference next month. Some members are adjusting policy based on climate considerations, potentially including higher capital charges for lending to fossil-fuel companies and bank stress tests that focus on the risk of rising temperatures to loan portfolios.

The group, which was launched in part as a response to the U.S. announcing in 2017 that it was pulling out of the Paris climate accords, includes regulators of all the world’s globally systemic banks. The central banks’ rising interest in climate dovetails with a flood of investor cash into products such as green bonds and into stocks of companies that make batteries and produce alternative energy. The U.S. has since rejoined the Paris accords.

Potential risks posed to the financial system by climate change include losses on loans or a decline in the value of assets, such as waterfront property and property repeatedly exposed to wildfires. Commercial banks and investors lend billions to companies that produce significant amounts of carbon dioxide, such as operators of coal power plants.

While climate change could affect macro economies, the effort right now is largely focused on regulating financial companies. Still, it takes the central banks beyond their traditional focus of managing inflation.

In March, the group proposed options to adapt monetary policy “to a hotter world" including central banks’ charging higher interest rates to lenders that pledge carbon-intensive assets as collateral. These might include corporate bonds backed by a coal-fired power plant, for example.

Some central banks are also debating whether to require banks to set aside more capital for loans to fossil-fuel companies and less capital on loans to wind- or solar-power companies.

Such a move would mean central banks would be influencing which parts of the economy get credit. Shifting in that direction would go against the long-held belief by central banks that they should avoid influencing lending decisions and could embroil them in political disputes over the extent of climate change.

Some central banks are moving more quickly than others, setting rules that U.S. companies will have to follow in affected countries and creating possible examples for the Fed and others.

In the U.K., Treasury chief Rishi Sunak this year changed the remit of the Bank of England’s interest-rate-setting committee to include “strong, sustainable and balanced growth that is also environmentally sustainable" as well as maintaining price stability.

The Bank of England has added climate risks such as rising temperatures and sea levels to its bank stress tests. In the past, stress tests mostly measured whether banks could withstand hypothetical economic scenarios such as big recessions or financial crises.

The U.K. institution last year began disclosing emissions from its physical activities, such as producing bank notes, the carbon footprint of its buildings and business travel. Regulators, including in the U.S., are increasingly focusing on improving corporate disclosure of carbon emissions and climate risks.

The Bank of France has started tallying the potential costs of climate change. A pilot climate stress test of banks and insurers found that the cost of insurance claims could rise as much as six times in parts of France by 2050 because of the increasing risk of droughts and flooding.

The European Central Bank, which oversees monetary policy and bank regulation in the eurozone, says climate already is covered by its mandate.

“Climate change can directly affect inflation. This may happen when more frequent floods or droughts destroy crops and raise food prices, for example," wrote Frank Elderson, a member of the ECB’s executive board and the chairman of the central banks’ climate group. “These issues clearly lie at the heart of our mandate."

The Bank for International Settlements, known as the central bank for central banks, has a program to finance renewable energy production. The ECB is helping to fund that program.

Fed Chairman Jerome Powell plans to participate in the June online meeting of the central banks’ climate group. The Fed’s membership doesn’t oblige it to adopt any policies, and Mr. Powell has stayed away from the plans proposed by other banks.

Some are concerned that Mr. Powell and other central bankers are overstepping their mandates.

Rep. Frank Lucas (R., Okla.) asked Mr. Powell in March what he should tell constituents concerned about the Fed’s “moving towards regulation and supervision with environmental policy objectives, potentially discouraging banks from doing business with entire sectors of the economy."

“We don’t tell banks what legal businesses they can lend to," Mr. Powell replied. “We’re at a very early stage of understanding the risks to regulated financial institutions from climate change. It is a risk that we think the public has every right to expect that we will assure that the banks do manage over time."

The central-bank group says regulators who don’t consider climate risks are failing in their jobs. “If you have a financial stability mandate and you are not looking at climate then you are not fulfilling your mandate properly," said Morgan Després, head of the secretariat of the Network for Greening the Financial System at the Bank of France in Paris.

Focusing on climate change forces the banks to go beyond the models they have long relied on for regulating lending and markets. At the Fed, the climate effort is being run by Kevin Stiroh, one of the bank’s top regulators, who previously headed supervision at the New York Fed.

“This is a case where the past is likely to be a less useful, a less informative guide about what’s going to happen, and models that we’ve all grown to trust might be less valuable going forward," he said in April.

This story has been published from a wire agency feed without modifications to the text.

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