Transforming finance in the era of the climate crisis

Finance climate change

Responding to the climate emergency and reducing growing inequalities are two key challenges of our age. Tackling these challenges requires a rapid transition to a net zero carbon economy. Such a transition won’t be achieved without the implementation of a wide range of radical policies as part of a transformational Green New Deal.

Green New Deal policies include fiscal interventions conducive to a low-carbon infrastructure, green industrial strategies, and environmental regulations that restrict carbon-intensive consumption and production. They also include social and tax policies that redistribute income and wealth and ensure that workers in high-carbon sectors won’t be hurt by the decarbonisation process.

Most crucially, a Green New Deal at the global level should be designed on the basis that the Global North is primarily responsible for the climate crisis that is now hitting much more severely the Global South. It’s thereby necessary that we take initiatives that will ensure that the Global South will be able to achieve climate mitigation and adaptation, free from neo-colonial approaches.

But Green New Deal policies  ̶  at the global or national level  ̶  will not be successful without a radical transformation of the financial system. Why is such a transformation necessary?

First, the financial system contributes to the generation of emissions by providing generous finance to polluting companies. This must stop if we want to avoid the climate disaster toward which we are heading.

Second, the level of investment that is essential for decarbonising our economies is massive. Although public finance has a key role to play in financing this investment, private finance  ̶  if properly regulated  ̶  will also be important.

Yet developing a climate-aligned financial system is not a trivial task  ̶  and entails various risks. This is so because the global financial system is very powerful nowadays. Financial institutions have an interest in presenting their financial products as ‘green’, even if these products have a minimal or negative contribution to decarbonisation.

And they can use lobbying in order to push for regulations and policies that support ‘financial greenwashing’. Actually, global finance is now increasingly interested in promoting green finance policies that contain a lot of ‘carrot’ and almost no ‘stick’.

In a recent report about green finance in the UK, my colleagues and I set out a plan for developing a climate-aligned financial system, minimising at the same time the risk of financial greenwashing. We do so by proposing measures that penalise the financiers of climate change and provide ‘carrots’ only when incentives rely on robust public approaches on what is green and what is not. The report was commissioned by the Shadow Chancellor of the Exchequer, John McDonnell, and was co-authored with Daniela Gabor, Maria Nikolaidi, Peter Rice, Frank van Lerven, Robert Kerslake, Ann Pettifor, and Michael Jacobs.

Our recommendations rely on three pillars. The first pillar refers to the institutional architecture of a climate-aligned financial system. This includes a public taxonomy that will identify which activities financed by the banking system and the financial markets can be considered as ‘green’ and ‘brown’, allowing for different degrees of greenness and brownness. It also includes the mandatory disclosure of climate-related financial risks by financial corporations and the establishment of a taskforce that will ensure the coordination of green finance initiatives with other Green New Deal policies.

The second pillar is about the Bank of England and banking regulation. We suggest that the mandate of the Bank of England should change or be re-interpreted such that the Bank makes a clear contribution to the reduction of climate risks. We also propose penalties for banks that offer brown securities in exchange for central bank liquidity and provide loans for carbon-intensive activities.

The third pillar refers to shadow banks. Shadow banking is a very important part of today’s global financial system. It captures financial activities that are outside the traditional regulatory oversight and has been identified as one of the main causes of the Global Financial Crisis.

A green finance strategy cannot be effective if it ignores the regulation of shadow banks. We suggest that climate issues be included in the regulation of shadow banking lending and derivatives markets. We also argue in favour of a green financial transactions tax.

On top of these three pillars, our report highlights the strategic role that green public investment banks and regional banks can play in the financing of renewable and energy efficiency projects. The long-term strategic vision of these institutions can counteract the short-termism that is prevalent in private finance nowadays and is particularly harmful for our climate.

Although our recommendations focus primarily on the UK, they can inspire green finance interventions in other countries. And that’s crucial: isolated climate regulations in national financial systems won’t be sufficiently effective. This is so because the financiers of polluting companies could move their activities into other countries where climate regulations are not in place; or polluters could simply borrow from abroad. A green transformation of the financial system won’t work if it’s not implemented in a global coordinating manner.

This might sound like a very challenging task. But climate change is probably the biggest challenge humanity has ever faced. We need to be bold and ambitious if we wish to address it.