Climate finance isn’t being deployed at the scale needed to reach Net Zero
Throughout all of the themes and topics up for discussion at COP28, there is one common thread: finance. To deliver on the goals of the Paris Agreement, the world needs to unlock trillions of dollars in climate finance, defined by the United Nations Development Programme as public and private funding for climate action.
The climate finance gap is especially pronounced among developing countries, which are often least responsible for causing climate change, but most vulnerable to its impacts. It’s why developing countries’ climate finance needs will likely be the biggest talking point at COP28. Last year, at COP27, parties acknowledged that climate finance flows pale in comparison to the needs of developing countries. To limit global warming to 1.5C, annual flows of climate finance need to be at least three times the size of the $803 billion provided in 2019-2020. On top of this, much of the funding countries receive is in the form of loans rather than grants, which exacerbates debt burdens and compounds development challenges.
We need better integration of climate considerations in development funding to tackle the climate crisis
For this reason, COP27 ended with a call to transform the global financial system, with a particular focus on reforming multilateral development banks. This was largely due to the efforts of the Prime Minister of Barbados, Mia Mottley, who called the current international finance system “broken…and downright unfair”. In the past year, the MDB reform agenda has been progressing through a series of multilateral summits. This included a Summit for a New Global Financing Pact in June 2023, which produced a roadmap of actions for key milestones such as UN and G20 Summits and World Bank annual meetings.
MDBs are striving to come up with completely new ways of working to address the climate crisis. This entails shifting their priorities. Rather than focusing purely on helping countries grow their economies, MDBs must now look at how they can help countries grow in a way that shields them from the impacts of climate change and keeps emissions to a minimum.
In October 2023, the World Bank took an important step in this direction, by unveiling a new vision. In it, the World Bank explicitly acknowledges the role of the climate crisis in intensifying other development challenges like poverty and food security. Previously, the World Bank’s core vision and mission prioritised the ‘twin goals’ of ending poverty and boosting shared prosperity, with climate a smaller focus. Now – recognising that these twin goals will not be met without addressing global challenges like climate change – the new vision aims to ‘create a world free of poverty on a liveable planet.’
MDBs must translate this kind of vision into meaningful action in two ways.
The first is embedding climate considerations into all lending decisions. This requires MDBs to calculate and minimise the emissions of any development projects they fund – such as building schools or renovating roads.
The second relates to climate finance, the funds which are specifically ringfenced for projects that mitigate climate change and build resilience, such as renewable power plants or flood-resilient buildings. A significant amount of climate finance already comes from MDBs. In 2021, 43% of the climate finance mobilised by developed countries was attributable to MDBs and multilateral climate funds. In 2022, MDBs also committed $60.7bn in climate finance for low and middle-income countries. Next to increasing this overall figure, MDBs must deploy these funds more efficiently and effectively. This involves four key actions:
- Developing pipelines of projects to invest in;
- De-risking climate projects to attract more private investment;
- Building capacity among regional and national development banks to deploy funds; and
- Leveraging a wider range of innovative financial instruments to make finance accessible and affordable to developing countries.
Three common challenges MDBs face to deploy climate finance efficiently
At COP28, the funds specifically for climate action will be under the spotlight. To deploy this climate finance efficiently and effectively, through the above-stated four actions, key barriers will need to be addressed.
Through our work with MDBs and development finance institutions (DFIs), we have identified three systemic challenges that MDBs face:
1. Validation of green technologies
Before investing in a climate technology or project, MDBs need to assess the level of risk involved, the profitability of the project or its ‘bankability’ and its climate credentials, among other factors. There are two challenges associated with this.
Firstly, the data needed to make this assessment is not always available, and green finance taxonomies and other frameworks are often difficult to apply to individual cases. As a result, MDBs currently lack the capacity to evaluate green technologies at the pace and scale needed.
Secondly, the desired ‘returns’ of climate projects – including more resilient communities – are not always easily quantifiable. Traditional definitions of bankability do not capture this climate dimension, and a perceived lack of bankable projects is therefore stopping financial institutions from deploying climate finance at scale.
2. Validation of green business models
Climate-friendly growth in the Global South requires new and innovative business models, such as virtual power plants and energy service companies, and other models which rely on cutting-edge technologies or changes in consumer and industry behaviour.
However, these new business models make for higher risk investments compared to traditional business models. This risk stems from uncertainty around whether these new ideas will work at scale and be accepted in each market. MDBs are beginning to build case studies on emerging business models, but this uncertainty continues to slow down investment decisions (and, in turn, flows of climate finance).
3. Selecting financial instruments
There are a number of different financial instruments at MDBs’ disposal, including loans, project financing, and guarantees. MDBs are experts in deploying these for traditional investments, such as providing debt for power plants. However, selecting the most appropriate financial instruments to support the new and innovative technologies and business models required for driving climate action presents a new challenge.
This, combined with the reality that market contexts across the Global South vary widely, means that MDBs continue to gather intelligence on which instruments are most suitable for each specific case. In this effort MDBs share common drivers: to maximise the crowding-in potential of their available financial resources, to allocate risks appropriately amongst market players and to stimulate self-sustaining markets that progress climate-positive activities.
These barriers all stem from the fact that financial institutions are still determining how to direct money specifically towards sustainable activities, how to define which activities are sustainable and how to assess and track the impact of their investments. They are particularly pressing for regional and national development banks, which receive funds from MDBs and channel them towards on-the-ground projects.
Three ways MDBs can collaborate to unlock climate action at unprecedented pace
One of the critical ingredients for addressing these challenges – and delivering climate finance at the scale needed – is collaboration. Without working together, MDBs risk duplicating efforts and creating inefficiencies which the urgency of the climate crisis does not afford. MDBs recognise this need; joint MDB climate working groups have been set up in recent years and, ahead of COP28, MDBs freshly stated their intent to work more closely together on climate finance. However, there is room for closer and more effective collaboration in a number of areas.
Our experience has highlighted three areas which any collaborative efforts between MDBs should prioritise:
1. Consolidating digital tools and sharing data
Many MDBs are developing proprietary digital tools to screen potential projects and track the impact of their climate financing. These tools have different applications, from assessing the energy saving potential of a green technology, to the risk profile of a potential investment. To speed up investment decisions, MDBs should look to make these tools, and the information their gather, available to their peers. This would entail harmonising the different assumptions implicit in each tool. MDBs could jointly assess the landscape for digital tools to identify gaps and priority innovation needs.
2. Coordinating investments
There is an opportunity to deepen investment coordination and strengthen co-financing. This was touched on by the recent statement of the Heads of Multilateral Development Banks Group, which mentioned the opportunity for ‘harmonising and mutually recognising each other’s policies and standards’ as a means of traversing MDBs individual mandates and business models to reduce frictions to co-financing.
Coordinating investments could help align MDBs working concurrently to push certain market levers or themes, and spread risk-burdens on very large-scale strategic infrastructure investments. Multiple MDBs coming together to contribute specialist expertise and different types of supportive financing would also help mobilise innovative business models. The International Development Finance Club is building out a project marketplace to ‘match’ development finance institutions with co-financing partners.
Philanthropic entities and national development banks, two other critical sources of climate finance, also have unique strengths – from risk appetite to country networks and knowledge – which MDBs can tap into by bringing them to the co-financing table.
3. Coordinating workstreams
MDBs can avoid duplicating efforts, like funding identical research projects, by coordinating workstreams. This entails sharing research outputs from previous projects and highlighting upcoming activities. At least five development finance institutions have funded projects to develop green finance taxonomies across nine regions in recent years, but it is not clear whether these efforts will be coordinated or structured around a shared aim.
There are recent examples of successful collaborative workstreams between development finance institutions. though Ten MDBs produced a set of principles together to align their operations with the Paris Agreement. MDBs are now implementing these principles internally. Each year at COP, MDBs share the progress they have made towards operationalising these principles and the lessons learned along the way. However, our experience suggests that MDBs would benefit from coordinating more frequently and earlier on in the process, to ensure the principles are applied consistently and that best practices are shared throughout.
COP28 arrives at a pivotal moment as MDBs are providing more climate finance than ever before, yet the gap between what is provided and what is needed is growing. Increasing available funds is one part of the solution, but MDBs also need to channel the money that does exist towards meaningful climate action more efficiently. There is no time to lose, and MDBs will see greater success if they join forces to address common problems.
Sharing learnings would enable better, more consistent, and quicker investment decisions. As well as building their own knowledge, to channel funds more quickly towards green solutions it is vital that MDBs and philanthropic funders also build capacity among local development banks to validate green technologies and business models.
There are, of course, structural barriers to collaboration among MDBs. In competition for government funding, it can be advantageous for one MDB to demonstrate more effective climate financing than its peers. But if, as outlined in their recent statement, MDBs are serious about their intent to ‘strengthen… collaboration for greater impact’ on climate, then consolidating digital tools, and coordinating workstreams and investments should be key focus areas for joint MDB action.