Inclusive Green Finance

In this report, economics experts present actionable policies for central banks to implement a “virtuous cycle” of inclusive green finance which promotes economic resilience and a just transition.  Green policies which neglect to address financial exclusion may have “unintended consequences”, exacerbating transition risks and jeopardising the necessary mitigation and adaptation investments with serious implications for financial stability, say the authors.

The authors, Ulrich Volz and Peter Knaack, state that target groups for financial inclusion – micro, small and medium-sized enterprises (MSMEs) and lower-income households – tend to be disproportionately exposed to climate risks, with adverse effects on financial inclusion.

High physical risk may drive financial institutions and private insurers away from customers at the margins of the financial system, say the authors. This leaves vulnerable segments of the economy without access to affordable private insurance and financial services.

The authors also state that well-intentioned green finance policies may exacerbate financial exclusion and feed a “vicious cycle” of transition risks. For instance, the credentials required to access affordable finance for climate adaptation and mitigation entail significant information costs which MSMEs and low-income households may be unable to meet. This risks excluding these groups, including sustainable businesses, from green financing channels.

A lack of access to affordable finance prevents a large section of the economy from investing in climate resilience and clean technology because they cannot finance the upfront investments. Ongoing financial exclusion means critical transition investments are not being properly financed and the economic system’s resilience to climate shocks is being undermined.

Inclusive green finance policies integrate two complementary central banking agendas: financial inclusion and green finance. Instruments can be divided into market-shaping or indirect policies, such as lowering barriers to market entry for microinsurance, and direct interventions such as targeted refinancing.

The authors outline three point of entry for central banks:

1. mitigate risk – provide green credit guarantee schemes to vulnerable segments of the population and MSMEs, and work to close climate insurance gaps
2. reduce information costs – invest in public information infrastructure and adapt risk-based environmental and social guidelines to be proportionate to loan size
3. affordable finance for exposed segments – channel green finance to excluded sectors by using digital finance platforms, targeted refinancing and directed lending

Central banks have already adopted a range of inclusive green finance policies, including the green infrastructure bonds issued by the Monetary Authority of Singapore which can be purchased in small denominations at ATMs, and through internet and mobile banking.

Finally, the authors propose a “careful and experimental” process which adjusts based on lessons learned and new information. They also call for a gender-informed and intersectional approach which considers various indices of socio-economic exclusion, including the “digital divide” separating those with access to information technology and those without.