COVID-19 has had catastrophic implications for economies around the world, catapulting many countries into some of the worst recessions on record. As policymakers and financial institutions work together to create economic recovery plans, there’s continued interest in ensuring that a post-COVID-19 economic recovery is ‘green’, ‘resilient’ and ‘inclusive’, giving rise to catch-phrases like ‘Building back better’.

For this to happen though, there needs to be massive investment in sustainable industry. But incorporating information around climate change and the environment into financial ecosystems is a relatively new concept - it was only in 2008 that the World Bank released its first green bond.

Although significant efforts are underway by regulators to address this, there is currently a lack of disclosure of climate-related information by companies. This leads to a high perception of risk by investors towards sustainable, climate-friendly projects which do not have sufficient evidence to prove that certain attributes, like the technology they use, are not risky. This can mean these projects struggle to garner private investment.

For example, a solar energy project, with plenty of data around the efficiency of the technology involved, may see good flows of investment. Whereas untested carbon capture technology with little supportive data may struggle.

This forms part of the many reasons, along with country-specific and macroeconomic risk, why many countries’ capital flows are not efficiently channelled towards sustainable, climate-friendly projects. There is a need to bring about change quickly and for dedicated institutions to promote information disclosure and de-risk sustainable projects, using innovative financial instruments to overcome the obstacles to a green recovery, such as a lack of private investment.

This is where green banks can play a pivotal role.

According to the Green Finance Institute’s State of Green Banks 2020, green banks can take several forms, but they are all motivated by the same public purpose – accelerating low carbon, climate-resilient sustainable development. Green banks seek to draw in capital from a variety of sources across the capital markets, from pensions and sovereign wealth funds, to multilateral development banks and climate funds. Most have public ownership and are largely funded with public capital.

‘Crowding In’ the Private Sector

Green banks help to reduce the perception of risk through a combination of improved information disclosure, accreditation – through carrying out selection and due diligence, and the offering of financial products that incentivise investment such as first loss debt (providing funding that would absorb losses on behalf of the private investors; a solution praised by Black Rock’s Chief Executive Larry Fink). These offers contribute towards one of the major objectives of a green bank: to ‘crowd in’ the private sector and create blended finance funds.

In the BEIS-funded UK Partnering for Accelerated Climate Transitions (UK PACT) program’s recent webinar entitled, The role of green banks and green finance instruments in a green recovery, moderator Dr Jeremy Gorelick, Strategic Advisor to the Green Finance Institute, provided insights into the current state of green banks. During the webinar, Dr Muhammed Sayed, Climate Specialist at the Development Bank of Southern Africa (DBSA) explained how its Climate Finance Facility (CFF) works. After consulting with major private banks in South Africa, the CFF created a portfolio offering credit enhancement products including first loss and tenor extension (extending the length of time remaining in the life of financial contracts) to draw in the private sector. The success of the CCF has led national development banks in neighbouring countries to consider following a similar approach to create dedicated climate funds for their national development banks.

“The main objective of the CFF was first to crowd in the private sector. And in our case it was paramount to ensure we de-risk projects which commercial banks deem to be risky,” noted Sayed.

The ‘Just’ Transition Towards Net Zero

Michael Sheren, Senior Advisor at the Bank of England, added that green banks are more important than ever due to the growing trend of net zero legislation and mandatory disclosure for companies of climate-related risk. These changes to the global policy environment offer huge economic opportunities for these banks to create fair equitable and just growth.

“Net zero legislation means it won’t just be a good thing to have a green bank, it will have to be part of the landscape of every jurisdiction” said Sheren.

It is crucial for green financial institutions to work with national development banks instead of competing with them. This means that their capabilities are extended across green sectors and that they are brought in to play an active role in the journey to financing low carbon transition thereby greening the current financial system, as well as increasing the prevalence of green finance.

But for the transition to low carbon to be just, green banks will need to recognise the social dimension of their funding.

Dr Amal-Lee Amin, Director and Head of Climate Change at CDC Group, added the example of coal reliance and ensuring that coal workers are not left behind and have access to stable, sustainable jobs in the green economy. “This pandemic has exposed a need for building back in an inclusive way and integrating resilience into our economies,” Amin said.

“How green banks recognise the social dimension is very important. The financial sector can have a very powerful role in helping governments and others to understand what will be needed to bring forward a recovery consistent with a just transition.”

Green Banks – Part of The Answer, But No Replacement for Systemic Change

Governments around the world are rolling out large stimulus packages with dedicated investments towards sustainable industries, such as renewable energy. As such, there is massive opportunity for institutions such as green banks to manage these funds and leverage increased investment for them to be used most effectively. Green banks and the greening of the financial sector can have a powerful role in helping governments to understand what’s needed to catalyse a recovery consistent with a just transition.

In parallel, however, it is essential that countries continue to mainstream climate objectives into investment decisions throughout their entire financial ecosystem. Otherwise, we have a situation where green banks work to catalyse investment in sustainable and climate-friendly projects while unsustainable ‘brown’ projects continue to receive significant funding.

To learn more about UK PACT’s work and the 2021 webinar series, visit ukpact.co.uk. For more information on green banks and their role in a green recovery, please see Dr. Gorelick’s article for UK PACT, ‘In finance, green is the new black,' and contact info@thepalladiumgroup.com for more information.