There is a need to adopt current best practice in the management of environmental issues, and redefine the banking sector’s role and ability to address systemic environmental risk

In the light of the Paris Climate Agreement and the United Nations’ Sustainable Development Goals, there is a growing conviction that financing environmentally-friendly growth is indispensable for sustainable economic development. Likewise, it was in 2016 that the G20 heads of state had, for the first time, acknowledged the need to ‘scale up green finance’ laying out a number of steps to make this happen. Subsequently, some countries issued strategies for greening their financial systems.

However, so far, there is no precise and universally accepted definition of green finance.  Definitions of green can be explicit or implicit. Some are very broad while others seem more technical and specific. Likewise, some are investment-driven, while some arise from ecological or ethical discussions. Nonetheless, simply put, green finance covers the financing of investments that generate environmental benefits as part of the broader strategy to achieve inclusive, resilient and sustainable development. The main aspects of green finance include sustainable investment and banking, where investment and lending decisions are taken based on environmental screening and risk assessment to fulfill sustainability standards, as well as insurance services that cover environmental and climate risk.

Given the massive investments needed to bring about a green transformation, the financial sector has to play a key role in allocating resources to sustainable investments and restrict financing activities that harm the environment.  In this respect, a number of central banks and regulators have started dealing with this challenge in practice.

The fact that the role of central banks seems crucial in promoting green finance by taking into account climate change and environmental risks in their policy decisions is attributed to a number of factors. The first relates to their role as guardians of financial and macroeconomic stability. Environmental threats may directly affect price stability through their impact on food and energy prices. Floods and droughts dependent on climate change may affect agricultural output, which subsequently influences food prices. Likewise, the impact of climate change is also witnessed on patterns of energy production and hence energy prices. Second, economies face a ‘physical risk’ from climate change and extreme weather, such as floods or storms.  These can damage the economy by disrupting or even wiping out individual businesses or the entire industries.  Basic changes in the environment could have an impact on economic and financial stability and the safety and soundness of financial firms. Because central banks are responsible for safeguarding financial stability, these risks need to be addressed by them in their financial stability and macro-prudential policy frameworks.

In terms of raising capital for green investments that mitigate climate change, green bonds are becoming an increasingly established financial instrument utilized by a number of central banks, development banks, state and municipal entities, as well as private companies. These bonds are debt instruments used for financing green projects that generate environmental benefits. Such projects could be in the areas of renewable energy, clean transportation and sustainable water management, among others. The structure, risk and returns are otherwise identical to those of traditional bonds.

With respect to Nepal, climate change is a real, briskly evolving and widespread hazard. The critical impacts of climate change appear to be on its water resources, especially glacial lakes, and its hydropower generation. Water supply infrastructure and facilities are at risk from increased flooding, landslides, sedimentation and more intense precipitation events expected to arise from climate change.

Despite these serious concerns, not much emphasis has been given to promote green finance in Nepal. Recently, however, in its Monetary Policy of 2017/18, Nepal Rastra Bank (NRB) has clearly mentioned that for managing risks of banks and financial institutions, environmental and social risk management manual would be developed.  Likewise, one of the objectives that need to be accomplished for achieving the vision of “an effective, efficient, inclusive and stable financial sector that contributes to broad based economic growth” as delineated in Nepal’s Financial Sector Development Strategy (2016/17-2020/21), is the development of a competitive financial system with social and environmental responsibility.

Furthermore, Nepal Rastra Bank is a member of Sustainable Banking Network (SBN), a knowledge-sharing network of banking regulators and banking associations set up in 2012 to support the development of environmental and social risk management by financial institutions and advance green and inclusive lending.   As of January 2017, out of 37 SBN member countries, 13 have already introduced green finance guidelines.

Green finance is a strategy for financial sector and broader sustainable development. There is a need to adopt current best practice in the management of environmental issues, and redefine the banking sector’s role in, and ability to address, systemic environmental risk.  Subsequently, national strategies and road maps for aligning financial system development with the needs of sustainable development need to be formulated.

Pant is with Nepal Rastra Bank