State-owned banks around the world need to phase out fossil fuel investments more aggressively to achieve the stated climate goals of their respective countries, the Asian Infrastructure Investment Bank said.
Public banks, especially in countries such as Russia, Saudi Arabia, Brazil, Malaysia and the United Arab Emirates, are generally more involved in legacy fossil fuel projects than private sector banks, said Erik Berglof, chief economist at the China-backed multilateral development bank, also known as the AIIB.
"Perhaps the first move [to move away from fossil fuel funding] is for state-owned banks to stop financing fossil-fuel projects overseas, while recognizing it would take time to restructure their domestic operations,” Berglof said Nov. 3 in an emailed interview.
The comment comes amid a gathering of diplomats Nov. 6 in Sharm El-Sheikh, Egypt, for the United Nations COP27 climate summit. Aside from raising ambitions for carbon reduction, a top item on the COP27 agenda is negotiating a finance mechanism to help vulnerable nations adapt to irreversible climate impacts that occur today.
In emerging and developing economies, oil and gas and conventional power projects have accounted for a larger share of public banks' total transactions in their portfolios in recent years, according to an AIIB report released Oct. 27, which cited transaction data from IJGlobal.
"It is difficult for state-owned banks to act by themselves. As alluded, they are tied to the [state-owned enterprise] sector and also government policies," Berglof said. "Hence, reforms in the [state-owned enterprise] sector that incentivize more green infrastructure will be necessary."
Berglof said the Oct. 27 report called for state-owned enterprises and state-owned financial institutions to phase out fossil fuel investment, not to divest those assets in bulk. "The asset pool is too large for the private sector to begin with, and it is not clear if the private sector has greater capacity to act," Berglof added.
Achieving net-zero climate goals by 2050 would require between US$3 trillion and US$6 trillion a year, depending on the estimate, according to the AIIB report. Markets cannot deliver on the task without the help of the public financial sector, particularly public banks, it added. Public lenders accounted for about 15% to 20% of banking assets worldwide as of 2016.
Public banks can support the green transition to net-zero in several ways. They can finance green projects with their own resources, the AIIB said; however, it added that this could tie up public resources. Another way would be to finance state-owned enterprises in their pursuit of climate goals and low-carbon investments. Public banks may also require their borrowers to follow environmental, social and governance standards and adopt climate disclosure requirements.
"Transparency is going to be incredibly important here. You are forcing banks to be transparent about what they're doing, carefully monitoring and challenging all the numbers that the banks declared," Berglof said.
In addition, public banks could help to mobilize private capital by helping increase the supply of bankable green projects. To address low returns from green investments, public banks are well placed to blend in concessional financing to reduce borrowing costs, improve the risk-return profile of these projects and make them viable for the private sector, the AIIB said.
Policy reform will also play an important part in making public banks step up green finance. State banks are tied to government policies, and, as such, any reforms in the state-owned enterprises sector that incentivize green infrastructure will be needed, Berglof said.
"For state-owned banks and [state-owned enterprises], it is important to plan and act as if a carbon price is in place to ensure the viability of the projects. In China, there are also policy measures to lower the financing cost of green projects. Policymakers will have to address the whole ecosystem," Berglof added.
