Global efforts to expedite the transition to a sustainable future require a significant shift in financial flows. The institutions governing finance play a vital role in achieving this objective. Central banks stand at the heart of this endeavour and are increasingly rising to the challenge. The recent launch by the People’s Bank of China (PBoC) of a carbon emission reduction facility (Cerf) is a case in point.
China’s dual commitment to carbon peak by 2030 and carbon neutrality by 2060 outlined in the 1+N policy framework foresees substantial changes in the structure of the country’s economy. The alignment of finance with this objective is critical. Over the past decade, China has already taken several steps in pursuit of this goal. Green lending through policy banks, support for the issuance of green bonds, and the establishment of a national carbon trading scheme are important illustrations. The PBoC’s launch of its new Cerf is a further milestone in that direction.
Cerf will provide targeted and discounted refinancing for loans to three areas at the core of the transition to a more sustainable economy: clean energy, energy conservation and environmental protection, as well as carbon reduction technology. The facility allows nationwide financial institutions to refinance 60% of such loans at a rate of 1.75% for an initial term of one year with the possibility for two rollovers. Compared to the widely accessed medium-term lending facility at 2.95%, the discount appears substantial. Yet the actual discount for banks will likely depend on the larger monetary policy environment and how banks access alternative funds.
The targeted policy is designed to create financial incentives using market mechanisms. The policy applies only to new loans, not existing ones. Loan decisions and thus the assessment of related financial risks remain with the banking sector. To apply for the funding, eligible banks must provide information on potential emissions reduction under proposed projects and publish regular reports on their progress subject to third-party verification.
In essence, Cerf is a green version of the targeted refinancing operations that have been used by central banks after the global financial crisis in a variety of ways. The Funding for Lending Scheme from the Bank of England (BoE) provided support for lending to households and the non-financial sector. Similarly, the Targeted Longer-Term Refinancing Operations of the European Central Bank (ECB) offered refinancing for bank lending to the real economy (excluding real estate).
While the BoE, ECB and several other central banks have deployed targeted refinancing operations to provide funding to large segments of the real economy, the PBoC and many of its peers have also used such targeting for a much more focused approach. In that vein, this summer the Bank of Japan announced a targeted refinancing tool to specifically support projects mitigating climate change. Similarly, the PBoC is introducing Cerf as a lever for structural monetary policy. Under this policy, liquidity is steered toward key sectors and weak links in the economy.
At the same time, the policy also seeks to decelerate funding to sectors with excess capacity such as real estate. It thus contributes to the structural adjustment in the economy and reflects a forward-looking approach to aligning monetary policy with the country’s broader objectives. Cerf is complemented by a separate refinancing facility to support clean coal which, in contrast to Cerf, is capped at 200bn yuan.
To ensure that Cerf is effective, three factors are critical.
First, transparency and verification are key. Data disclosure by participating financial institutions and their borrowers in the context of the application as well as during the entire term of Cerf refinancing is an important first step. Verification by third-party institutions as well as the PBoC itself is an additional indispensable factor to ensure adequate, independent, and science-based evaluation.
Second, the facility must provide enough of an incentive to influence bank lending decisions, and at the same time support a prudent and efficient allocation of funds. Its modalities in terms of interest rate discount, caps on loan pricing, quotas and maturities are key pillars for that.
Finally, additional central bank funding in support of China’s carbon peak and carbon neutrality objectives may free up financing space for projects that run counter to these goals. Complementary policy measures to mitigate against this risk are vital.
The PBoC’s experience will be invaluable for the international community. Central banks stand to benefit from lessons drawn from China’s approach to structural monetary policy in terms of economic linkages and policy innovation. G20 leaders have repeatedly pledged the use of all policy levers in their pursuit of inclusive and sustainable prosperity.
Monetary policy must be an integral component of this ambition. The PBoC just took an important step in this direction.
This article was first published on Caixin Global.
This page was last updated January 6, 2022
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