Academics make case for green credit guidance

A new paper argues that financial authorities should deploy incentives and targets to align financial flows with governments’ decarbonisation plans.

The report from academics led by the UCL Institute for Innovation and Public Purpose adds to a growing body of literature suggesting that the risk-based framework currently dominating financial policy related to the green transition is not having the necessary impact. It cites research showing that bank credit to carbon-intensive sectors has continued to increase in the nearly seven years since the Paris climate agreement.

Instead, the authors propose an “allocative green credit policy” framework, designed to drastically reduce the flow of finance towards areas that are incompatible with the net-zero transition, and promote it to green infrastructure projects and certain priority sectors.

The report is the latest to suggest that aligning regulators’ toolkits with governments’ net-zero targets may be the most effective way of addressing climate-related financial risks, as well as being necessary to ensure that these targets are met in the first place.

Economists Nick Robins, Simon Dikau and Ulrich Volz of the London School of Economics made a similar argument in a blog last year on net-zero central banking.

“Using their role as guardians of the financial system, central banks need to ensure that the financial sector at large aligns with net-zero targets, which would also accelerate the transition in the real economy and help to avoid macroeconomic and financial instability in the future,” they wrote.

The UCL academics cite several problems with the current risk-based approach, which they characterise as outsourcing the pace and direction of decarbonisation to private capital. One is its failure to account for the radically uncertain nature of climate change and green innovation. They also cite the threat of regulatory capture – such as the effect of corporate lobbying on the taxonomies used to align instruments with net zero.

Some central banks have begun to consider or deploy more proactive climate-friendly policies, such as the decision by the Bank of England (BoE) to overhaul its corporate bond purchases. But the report suggests that the impact of these policies is limited by each central banks’ commitment to current monetary orthodoxy. For example, the BoE’s policy – announced as a key pillar in its climate strategy last year – is being abandoned as the bank unwinds its quantitative easing programme in a bid to control inflation.

The People’s Bank of China (PBoC) appears to have gone far further than any of its G20 counterparts in proactively seeking to influence banks’ credit allocation in support of the green transition. Governor Yi Gang claimed recently that its green finance instruments have provided over US$31bn to banks in the country, and are supporting emission reductions of over 60mn tonnes of carbon dioxide.

Although doubts have been raised about the veracity of the claims raised by the scheme’s beneficiaries, and China’s financial system has many unique characteristics, experts have suggested that key elements of the PBoC’s policies could be transposed elsewhere.

The UCL paper stresses that an effective green credit policy regime would not just be limited to banks, and instead include the entire ecosystem of institutional capital such as private equity and the repo market. It argues that the decarbonisation of the financial system will not be possible without addressing the increasing importance of market-based finance, which has so far escaped most climate regulation and could replace banks in providing support to transition-incompatible sectors.