Striking a balance between environmental sustainability and economic development is crucial, especially in the context of climate financing, where the challenge lies in funding green initiatives without compromising growth.
In almost 60 per cent of banks in emerging market and developing economies (EMDEs), lending for climate-related investment accounts for less than five per cent of their overall portfolios, and more than one-quarter offer no climate financing at all, according to a new World Bank report.
This is significant because, in developing economies, banks dominate the financial sector, unlike in advanced economies where the financial sector is more diversified. Climate change is expected to significantly impact economic opportunities and development outcomes in EMDEs, requiring far greater investment than they currently receive. Banks in EMDEs have the potential to play a larger role in closing the climate financing gap.
“Emerging market and developing economies face substantial financing gaps in low-carbon, climate-resilient investments. We need to step up climate action and crowd in private investment for countries most in need,” said Axel van Trotsenburg, World Bank Senior Managing Director of Development Policy and Partnerships. “This requires collective action, and the banking sector is indispensable in this transition process. It can play a pivotal role in financing a green, low-carbon, and sustainable development path.”
India’s Outlook
Currently, green finance flows in India are falling far short of the country’s current needs; they only account for around three per cent of total foreign direct investment (FDI) inflows to India, according to the Landscape of Green Finance in India 2022 report, published by Climate Policy Initiative.
“Annual climate finance needs are estimated to increase substantially, reaching well beyond USD 10 trillion annually by 2050. Failing to meet these financial demands will exacerbate the rise in global temperatures, simultaneously intensifying the socio-economic consequences of climate-related disasters. Unfortunately, despite the stark cost-benefit analysis, climate finance remains significantly inadequate," said Girish Chandra Murmu, Comptroller and Auditor General of India.
Murmu also highlighted the need for sustainable climate finance to balance growth with environmental protection.
The government is also making efforts to tackle climate finance-related obstacles. In budget 2024-25, the Modi government has unveiled a climate finance taxonomy- a system that classifies which parts of the economy may be marketed as sustainable investments. It helps guide investors and banks in directing trillions toward impactful investments to tackle climate change.
Worldwide Efforts
Globally, banking authorities are testing new approaches to support climate financing, without compromising on the important goals of financial sector stability and inclusion for underserved people. For example, the adoption of green and sustainable taxonomies – a classification system that identifies activities and investments to move countries toward specific environmental and other targets – is essential to increasing climate-related lending. Today they cover only 10 per cent of EMDEs compared with 76 per cent of advanced economies.
“Adaptation is underfunded— only 16 per cent of domestic and international climate finance in emerging market and developing economies is channelled for adaptation. Out of this small share, 98 per cent is either public resources or official financing,” said Pablo Saavedra, World Bank Vice President for Prosperity.
Saavedra added that in addition to increased climate lending from banks, reducing this gap requires larger capital and insurance markets in developing economies to provide essential long-term funding for critical climate-resilient infrastructure. It’s also important to improve financial access for people, particularly those in vulnerable groups.
Major Requirements
Based on new data, the World Bank report highlighted a divergence in the resilience and stability of financial sectors. An analysis of 50 countries, which represent 93 per cent of total bank assets in EMDEs, found that 30 per cent of these countries are likely to face high financial-sector risks in the next 12 months. The majority do not have an adequate policy framework and the institutional capacity to deal with financial stability challenges.
The report also called attention to the excessive holdings of government debt by domestic banks – an Achilles heel for some economies – particularly those with weaker macroeconomic policies, facing public debt sustainability challenges. Between 2012 and 2023, the exposure of banks to government debt surged by over 35 per cent.
World Bank recommended countries strengthen bank buffers well in advance, operationalize financial safety nets, conduct stress tests, and put in place a variety of essential tools. These include strong interagency crisis-management mechanisms, fully operational emergency liquidity assistance, robust bank resolution frameworks, and adequately funded deposit insurance systems to reduce the likelihood of financial stress and spillovers to the overall economy.
Additionally, developing economies should consider introducing disclosure requirements for banks’ exposures to the government to encourage more prudent risk-taking by banks and foster market discipline.
