In almost 60% of banks in Emerging Market and Developing Economies (EMDEs), lending for climate-related investment accounts for less than 5% of their overall portfolios.
A new World Bank report finds that more than one-quarter of the banking sectors offer no climate financing at all.
This is significant because in developing economies, banks dominate the financial sector, unlike in advanced economies where the financial sector is more diversified.
The report, Finance and Prosperity 2024, is the inaugural edition of an annual series that examines financial sector developments and vulnerabilities in low- and middle-income countries. The report includes two special topics: Sovereign-Bank Nexus and Climate and the Banking Sector. It was released by the by the World Bank on Thursday.
The Finance and Prosperity is an annual World Bank report that examines financial sector developments and vulnerabilities in low- and middle-income countries.
These countries have much to gain by strengthening their financial sectors as they strive to support job creation, attract private capital, address climate change, and tackle other development challenges.
This year’s edition of the report analyzes new data and highlights a growing divergence in financial sector resilience and stability among emerging market and developing economies (EMDEs) and critical trends in climate finance.
It finds that while financial sector risks in the larger and higher per capita countries are moderate, half of lower-income countries face significant risks over the next 12 months. According to the report, nearly 70 percent of countries facing high financial sector risks are currently not adequately prepared to handle financial stress.
The report also identifies a particular risk facing financial sectors in several countries: a large and growing exposure to sovereign debt. This exposure surged to its highest level in the past decade.
According to the report, climate change is expected to have a significant impact on economic opportunities and development outcomes in emerging markets and developing economies, requiring far greater investment than they currently receive. Banks in EMDEs have the potential to play a larger role in closing the climate-financing gap.
Axel van Trotsenburg, World Bank Senior Managing Director of Development Policy and Partnerships said emerging market and developing economies face substantial financing gaps in low-carbon, climate-resilient investments.
“We need to step up climate action and crowd in private investment for countries most in need. This requires collective action, and the banking sector is indispensable in this transition process. It can play a pivotal role in financing a green, low-carbon, and sustainable development path,” he said.
Globally, banking authorities are testing new approaches to support climate financing, without compromising on the important goals of financial sector stability and inclusion for underserved people.
For example, the adoption of green and sustainable taxonomies – a classification system that identifies activities and investments to move countries toward specific environmental and other targets – is essential to increasing climate-related lending. Today they cover only 10% of EMDEs compared with 76 % of advanced economies.
Pablo Saavedra, World Bank Vice President for Prosperity said adaptation is underfunded— only 16% of domestic and international climate finance in emerging market and developing economies is channeled for adaptation.
“Out of this small share, 98% is either public resources or official financing,” said Saavedra.
“In addition to increased climate-lending from banks, reducing this gap requires larger capital and insurance markets in developing economies to provide essential long-term funding for critical climate resilient infrastructure. It’s also important to improve financial access for people, particularly those in vulnerable groups.”
Based on new data, the report highlights a divergence in the resilience and stability of financial sectors. An analysis of 50 countries, which represent 93% of total bank assets in EMDEs, found that 30% of these countries face high financial-sector risks in the next 12 months.
The majority do not have an adequate policy framework and the institutional capacity to deal with financial stability challenges.
The report also calls attention to the excessive holdings of government debt by domestic banks – an Achilles heel for some economies – particularly those with weaker macroeconomic policies, facing public debt sustainability challenges. Between 2012 and 2023, the exposure of banks to government debt surged by over 35%.
The report recommends countries to strengthen bank buffers well in advance, operationalize financial safety nets, conduct stress tests, and put in place a variety of essential tools.
These include strong interagency crisis-management mechanisms, fully operational emergency liquidity assistance, robust bank resolution frameworks, and adequately funded deposit insurance systems to reduce the likelihood of financial stress and spillovers to the overall economy.
Additionally, developing economies should consider introducing disclosure requirements for banks’ exposures to the government to encourage more prudent risk taking by banks and foster market discipline.
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