What would a green dual interest rate environment look like?

February 15, 2024|Written by

The European Central Bank (ECB) has been resisting calls for a dual interest rate for green lending but the tide could be turning after French president Emmanuel Macron endorsed green dual interest rates at Cop28. Now, it’s a concept the central bank seems to be considering.

Major central banks like the ECB, Federal Reserve and Bank of England (BoE) already have the tools in place to offer dual interest rates, with many advocates pushing for lower rates for green projects like the financing of greener homes. ECB executive board members Isabel Schnabel and Frank Elderson have spoken in favour of dual rates, although Elderson has cautioned that a lack of data to validate green labels would currently make this too challenging for the central bank.

Still, some think it’s possible that the ECB could introduce green interest rates as soon as the summer.

“Now that we are also having inflation decreasing in Europe, I think it will give more openness and leeway to the European Central Bank to adopt such a type of policy,” said Maud Abdelli, who leads the WWF’s greening financial regulation initiative.

How will dual rates help green projects

Dual interest rates are a way for central banks to offer lower rates to encourage banks to lend more to specific sectors. In the case of a green interest rate, the idea is to have a lower interest rate for green projects than other types of lending.

In an inflationary environment like the one the world is in right now, this would allow more investment in renewable energy projects, which often have high upfront costs. Fossil fuels tend to be favoured as the infrastructure is already in place, and banks and companies can make more money in the short-term. Still, a recent study found that while green energy might be more expensive at first, they are cheaper than fossil fuels long-term.

The current high cost of borrowing is one reason why advocates are bringing up the argument for dual interest rates, said Sayuri Shirai, a visiting fellow and advisor at the Asian Development bank and former policy board member at the Bank of Japan (BoJ).

“The interest is so high, a lot of companies are not doing well, so they stopped doing renewable energy supply projects,” she said.

And while some economists worry about the inflationary effects of dual interest rates, others say it could help combat inflation.

“It can be used by each and every central bank because it’s really a way to fight inflation,” said Abdelli. This is especially true in the case of renewable energy, she says, as fossil fuels can increase inflation. For example, Russia’s invasion of Ukraine heavily impacted inflation in the euro area, pushing up prices of gas and oil. An increase in renewable energy investment would ultimately help fight reliance on fossil fuels and bring down inflation.

Lydia Prieg, head of economics at the New Economics foundation, said that any type of dual interest programme should have a green taxonomy in place to limit greenwashing.

“We don’t want to be offering low rates of interest to people who aren’t actually greening the economy or might even be doing harmful activities,” she said.

Because the EU is still working out kinks in its taxonomy, she expects that the ECB will release a small pilot programme before offering a lower green interest rate more broadly.

Dual interest rates are not new

Dual interest rates are not a new concept. After the financial crisis, the ECB offered lower interest rates to banks under the targeted longer-term refinancing operations (TLTRO) while the BoJ’s green lending programme provides zero interest to lenders supporting renewable energy projects.

“The mechanism is there in the EU and the UK, it just hasn’t been used specifically for green purposes,” said Prieg.

But these programmes are not without controversy. The BoJ’s lending programme, for example, has come under scrutiny because it includes fossil fuel companies in its bonds. Meanwhile, the Japanese government plans to include controversial tech like carbon capture, green hydrogen and ammonia in its green bond issuance initiative. Because the BoJ follows government policy, some of this controversial tech is also reflected in the central bank’s green lending programme.

“The Bank of Japan’s intention is good but the impact is very limited,” said Shirai. Ultimately, they are just following the policies that the government has put in place.

Central banks that want to implement lower interest rates for green projects need to make sure they not only have the mandate to do so, but that they have the right tools in place, she said.

One issue with the BoJ progamme, for example, is that Japan does not have a green taxonomy so the central bank has no framework to base projects on. Meanwhile, while lending is supposed to only go to companies that use the Task Force on Climate-related Financial Disclosures recommendations, the standards are not required by the Tokyo Stock Exchange, Shirai said, resulting in a lack of consistency.

Central banks need to know which projects are green and which are carbon-intensive, but “they don’t have the authority” to decide that; governments do, she said.

“That kind of lending should be done by the government because the government can also provide subsidies and do the guarantee for the bank loans… If central banks do it, [it is] very politically challenging,” she said.

Others think that dual interest rates can actually save governments money, especially in places like the EU and UK. Instead of governments providing subsidies or direct investments to help with the transition to a green economy, lowering the borrowing rate of banks encourages private funding of green projects.

“One of the big appeals politically of this dual rates approach is it allows the state or Europe as a whole to support green investments, but without actually spending treasury or government money,” said Prieg.

This page was last updated April 5, 2024

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