Mitigating climate change, reversing nature loss and reducing our dependence on fossil energy requires massive public and private investment. Still, many essential projects for this transition require more upfront capital investment before becoming operational, exposing them to higher interest rate environments.
By leveraging innovative monetary policy instruments, central banks can unlock the full potential of the financial system to drive the change our planet so urgently needs. However, there is limited development of monetary policy tools such as corporate asset purchase programmes, collateral frameworks, foreign exchange reserves and reserve requirements that take into account climate and environmental factors. Only five out of 50 central banks offer subsidised loans and green preferential targeted refinancing lines according to WWF’s Sustainable Financial Regulations and Central Banking Activities (SUSREG) 2024 assessment.
Why are green targeted refinancing operations important?
Central banks can provide liquidity to financial institutions through targeted refinancing operations to support specific economic objectives. TROs have been effective for increasing finance in certain sectors by lowering the borrowing costs for firms without increasing banks’ risk taking. Analysis shows that green TROs are successful in lowering the overall energy transition costs. A green rate of 200 basis points would reduce these costs by 23.7% (€3.7bn) and could even decline by 52.7% (€8.2bn) if the cost of equity decreases in parallel.
The European Central Bank’s targeted longer-term refinancing operations programme has been criticised for inadvertently favouring carbon-intensive industries, as banks tend to lend more to high-emitting sectors to qualify for the preferential rates. Analysis shows that more than 80% of total cumulated loans issued under the ECB’s TLTRO III programme was geared towards polluting companies. The carbon dioxide emission content of new bank loans amounted to approximately 151 carbon dioxide megatons, corresponding to 8% of overall carbon dioxide emission in the euro area at the end of 2019.
In our view, TROs can augment the positive impact from the ECB’s actions on climate change, creating the right incentives for a greener financial system and supporting an orderly transition to a net zero economy. Outside the euro area, the Magyar Nemzeti Bank has begun incorporating green aspects into its monetary policy toolkit, such as through its Green Mortgage Bond Purchase Programme.
Asian central banks are filling some gaps
China has taken a pioneering step in this direction with the launch of its Carbon Emission Reduction Facility – a green TLTRO programme introduced by the People’s Bank of China in 2021. By the end of 2023, the outstanding amount of CERF registered Rmb541bn ($76bn) and enabled more than 150m tonnes of emission reduction.
Building on this momentum, the PBoC has now extended the green lending programme until 2027 to boost clean energy and environmental protection efforts. This will align with the country’s carbon peaking and net-zero goals, including an ambitious target of Rmb15tn ($2.1tn) energy-saving industry by 2030 and renewable energy capacity at 1,653GW.
Since 2021, the Bank of Japan has rolled out a funding scheme of a total ¥3.6tn ($26bn) of 0.1% interest per annum loans to 63 financial institutions targeting activities aimed at combatting climate change. The Funds-Supplying Operations to Support Financing for Climate Change Responses programme includes green loans, green bonds, sustainability-linked loans and bonds with performance targets related to efforts on climate change and transition finance. The central bank offers loans twice annually that can be rolled over until 2030 to financial institutions.
In Malaysia, given the critical contribution of small and medium-sized enterprises to economic growth and their role in corporate supply chains, the Central Bank of Malaysia initiated the Low Carbon Transition Facility and High Tech and Green Facility to help SMEs build their technical capability and improve access to finance. To date, more than RM1.2bn ($250m) in financing has been approved, supporting more than 550 SMEs in the low-carbon transition journey.
Lessons for the global community
To further ‘green’ TROs, there is a range of actions central banks could consider taking . These include applying the lessons learned from the likes of CERF and integrating nature-related considerations to stimulate nature-positive bank lending. Nature degradation can have implications for central banks in delivering on their mandates and macroeconomic implications of nature-related risks could have a direct impact on price stability and on monetary policy.
For TROs with collateral requirements, the collateral provided needs to be carefully selected to avoid any counterproductive effect (see also concerns raised about Bank of Japan’s lending programme).
To qualify for green TROs, the eligibility criteria should include both climate and nature transition plan requirements. While financial institutions are expected to have different strategies for different companies in the transition, companies must have developed and publicly disclosed an entity-level transition plan.
In addition to the emissions profile of a bank lending portfolio, central bank refinancing rates should be differentiated based on the green performance of banks. For example, banks have been assessed for their performance on green credit in China since 2017.
TROs should include and prioritise SMEs in the spirit of green financial inclusion. This can be augmented by a credit guarantee scheme to provide credit enhancement for higher risk enterprises or projects.
Central banks that wish to take a pilot or phased approach could consider rolling out TROs in green finance pilot zones like those in China. These may amplify and concentrate the impact of TROs on the local economy.
Central banks should review the effectiveness and impact of financing to ensure optimal allocation and distribution of resources. An example is refinancing loans for customers to purchase electric vehicles vis-a-vis loans for manufacturers to produce EV at scale.
By linking the availability of economical, long-term funding to the green performance and emissions profile of bank lending portfolios, TLTROs encourage a fundamental shift in the flow of capital towards green and sustainable sectors. It’s not just a necessary policy instrument innovation, but an important policy lever, putting all hands on deck for the benefit of our planet and its people.
Adam Ng is Asia Pacific Lead and Maud Abdelli is Global Lead, Greening Financial Regulation Initiative, WWF.
