To place Asian economies onto a sustainable development pathway requires an unprecedented shift in investment away from greenhouse gas, fossil fuel and natural resource intensive industries towards more resource efficient technologies and business models. The financial sector will have to play a central role in this green transformation. Important aspects of green finance are sustainable investment and banking, where investment and lending decisions are taken based on environmental screening and risk assessment to meet sustainability standards, as well as insurance services that cover environmental and climate risk.

Against the backdrop of climate change vulnerability and the need for a reduction in carbon emissions, huge investments in green and climate-resilient infrastructure are needed across the region. The infrastructure gap in developing Asia has been assessed by the Asian Development Bank to amount to $26.2 trillion between 2016 and 2030 or $1.7 trillion annually (ADB 2017). Of the $26.2 trillion needed by the ADB’s 45 developing member countries, $3.6 trillion are specifically required for climate change mitigation and adaptation costs, of which, 56 per cent is needed for power, 32 per cent for transportation, 9 per cent for telecommunications and 3 per cent for sanitation. For Southeast Asia alone, the ASEAN Investment Report 2015 estimates that $110 billion a year will be needed for infrastructure investment in power, transport, information and communication technology, and water and sanitation through 2025 (ASEAN Secretariat and UNCTAD 2015).

All of this investment will have to be sensitive to environmental, climate and associated policy risks. Funds for this investment will need to come from both the private and public sectors, including both domestic and international sources. The financing of sustainable infrastructure requires new approaches to mobilising and intermediating long term finance in the region. Integrating environmental and social considerations into lending decisions and product design is only a first step in making the financial systems instrumental in funding the required transformation towards a green economy in the region. The funding of energy efficiency, renewable energy and sustainable infrastructure requires new concepts and new financial instruments adapted to local circumstances. Green banks, green bonds and appropriate regulatory frameworks need to be introduced in a co-ordinated framework. Last but not least, there is also a need for developing climate risk insurance, including risk mitigation instruments for agriculture, which for many countries in developing Asia remains a major economic sector.

There is little doubt about the importance of implementing an adequate environmental policy and regulation and the need for targeted industrial policies to create the conditions for sustainable investment and thereby enhancing green, low-carbon growth. But there has been a growing recognition that to achieve a green transformation, it is also crucial to align the financial system with sustainability goals, given that the financial system is the place where investment decisions are taken or influenced. The need for financial institutions to “incorporate climate-proofing and climate resilience measures” (UNFCCC 2015: §44) has also been recognised in the Paris Agreement. Accounting for climate and other environmental risk is equally important in terms of safeguarding the stability of financial systems. A failure to address systemic sustainability challenges, in the longer-term, will impinge on the growth and returns of individual firms and economies at large, with repercussions for the financial institutions that have financed non-sustainable investments. There is, hence, a strong case for financial institutions as well as for financial regulators to take account of environmental, social and governance (ESG) risks.

For the time being, very few financial institutions in Asia systematically integrate ESG factors into their lending or investment decision-making processes. Green banking and sustainable investment are still a niche market, and few staff in the industry has been trained on ESG issues. But the situation is changing.

Several Asian countries have been at the forefront of introducing sustainable finance guidelines and regulation. Financial authorities in Bangladesh, the PRC, Hong Kong (China), India, Indonesia, Japan, Mongolia, Singapore and Viet Nam have already started taking concrete steps to align the financial system or parts of it with sustainable development. Financial authorities in Cambodia, Lao PDR, Nepal, Pakistan, the Philippines, Sri Lanka and Thailand are currently working on green finance policies.

Many different instruments can be used to enhance green finance. The most adequate choice of instruments will depend on the specific country context; while certain market-based instruments may be more appropriate in one country, another country may opt for more interventionist policies. Yet what is needed in all countries to enable a fundamental cultural change in financial markets and to mainstream sustainability in financing and investment is a co-ordinated and systematic approach involving all relevant stakeholders. Financial authorities need to set incentives for financial firms to enhance green finance and provide support and guidance, but experience from different countries suggests also that often rules and regulations are needed for financial firms to act.

To successfully align the financial system with sustainability goals, financial governance should target the following goals:

  • Raising awareness among regulators and market participants in the financial sector of environmental and climate risks
  • Developing capacities in the financial industry for environmental risk analysis and management through knowledge building and sharing
  • Building up the capacities in the financial industry needed to develop sustainable financing practices and new lending instruments for financing sustainable projects such as renewable energy
  • Enhancing transparency through ESG disclosure requirements
  • Providing incentives, where needed, to banks and non-bank financial institutions to finance green projects
  • Supporting the development of new market segments such as the green bond market or climate risk insurance
  • Developing long-term, local currency refinancing sources for banks to enable them to extend long-term credit

To achieve these goals, a dialogue among all relevant domestic stakeholders is needed. Public financial institutions, including central banks, development banks and public pension funds, can play an important role in developing and promoting the adoption of new green financial products. International initiatives and networks such as the UNEP Finance Initiative, the Sustainable Banking Network, the Sustainable Stock Exchanges Initiative, the G7 Initiative on Climate Risk Insurance (“InsuResilience”) and the G20 Green Finance Study Group can help countries leverage on international experiences.

While green finance and investment is currently still a niche market in Asian financial systems, growth rates have been high, and different Asian markets have already seen various green financial innovations. The challenges for achieving a green transformation to a low-carbon economy are large; aligning the financial sector with sustainable development will be a key element for Asian economies to succeed.

Ulrich Volz is Head, Department of Economics and Associate Professor of Economics at SOAS University, London. He is also a senior research fellow at the German Development Institute. This article draws on a study written by the author that was recently published by the Asian Development Bank Institute.

Ulrich Volz, Head, Department of Economics and Associate Professor of Economics, SOAS University, London