Nov 09 2022

Climate Finance and Green Lending - Finance Day, COP27

By Professor Juan Pablo Rud and Mariana Bernad, Postgraduate Research Student, Department of Economics

Relevant United Nations’ SDG goals:

Finance is a focal point in COP discussions, because it lies at the heart of strategies that provide relief to those countries or households that are most affected by climate change. Access to finance, through credit, insurance or relief packages is vital to ensure targeted support for the most vulnerable. But it can also be an important instrument for change, by providing the means for adaptation that either reduce exposure to shocks, or by channelling resources towards investments that can help achieve net-zero objectives. It can also protect communities that are most likely to lose in the energy transition, such as coal miners or workers in high-pollution industries.

Addressing the topic of finance at a supra-national level is vital. Finance flows are lacking the speed needed to reach the 2015 Paris Agreement goals. The pledge of $100 billion per year has not been met yet, and increasingly unaffordable loans rather than grants are too pre-eminent. 

The quantity and quality of climate-related financial flows need to improve. One way to incentivise this is through a commitment of the banking system to climate change principles. These principles seek to align their members’ practices to the Paris Agreement goals, or at least to disclose climate change and Environmental, Social and Governance (ESG) issues to promote more informed investments. One example is the 120-bank strong Net-Zero Banking Alliance.

Banks voluntarily committing to these principles are signaling “green behaviour” to publics, but it remains unclear if actual measures are being implemented. In our unpublished working paper “Walking the Talk? Green Management and Green Lending by Banks” we try to shed some light on this regard. We use data from the European Bank for Reconstruction and Development’s third Banking, Environment, and Performance Survey (BEPS III), a unique dataset on banking decision-making and managerial expectations on climate change for banks in Emerging Europe, Northern Africa, and Central Asia to see if banks committing to climate change principles are implementing greener management and lending practices.

In our paper we focus on four climate principles: Principles for Responsible Banking, Science Based Targets initiative, Task Force on Climate-related Financial Disclosures, and Principles for Responsible Investment. For the green practice measures, we build two indices. The Green Management Index considers if the bank employs environmental and climate change policies and targets, if it counts with a manager responsible for environmental and climate change issues, and if it undertakes a quantitative analysis of potential climate-change-related risks. The Green Lending Index considers if the bank undertakes environmental or climate change impact assessments, if it rejects loans for ESG reasons, and if it provides energy efficiency incentives for loans.

We find that banks committing to at least one principle show substantially larger green-management and green-lending practices. This suggests that committing to these principles is not a form of greenwashing, as it seems to come with practices that favour a transition to more sustainable practices and investments in low- and middle-income countries.

This is an example of lending practices in the financial sector moving in the right direction. But is this enough? Probably not, as the transition to a net-zero emission economy needs an increase in total climate finance flows of around 200% to 400% according to COP27. This increase is substantial when comparing it to the 5% increase that took place from 2013-14 to 2017-18. If this was hard enough, Oxfam estimates that the actual climate-specific net assistance developing countries are receiving from developed economies is significantly lower than the levels of financial flows that the latter report. In addition, most of these flows are in the form of public loans, which add to the developing countries' debt burden.

These and other timely climate-related issues will be addressed this week during COP27.