Changing course for the climate: How financial policy can accelerate the green transformation

A large proportion of global capital is still being channelled into climate-damaging activities - even though the clock has long been ticking to meet climate targets. How can investments be channelled more into sustainable and less into climate-damaging projects in the future? A research team from Witten/Herdecke University (UW/H) and the Institute for Ecological Economy Research (IÖW) has investigated this question and made three clear recommendations to policymakers:

(1) Green investments must be made more attractive for financial market players,
(2) fossil investments unattractive and
(3) public funds more targeted.

Globally, there is a huge financing gap for sustainable investments: According to the Climate Policy Initiative, around seven trillion US dollars a year are needed worldwide to achieve the Paris climate targets, and in Germany alone, the additional investment required is between 60 and 100 billion euros a year. One of the major challenges: Investments in fossil fuel projects are still considered particularly profitable and low-risk - with fatal consequences for the environment and society.

Bankability as a lever for green transformation

"Green investments often fail due to their 'bankability', which describes the relationship between the risk and return of an investment. The lower the risk and the higher the expected return, the greater the bankability," explains project manager Prof Dr Joscha Wullweber from UW/H.

The bankability of many sustainable projects is far too low for the financial sector to invest in them, the researchers' analysis shows. In contrast, the bankability of numerous climate-damaging projects remains high. This is despite the fact that the European sustainable finance regulation aimed to strengthen environmental criteria for investments. A more ambitious policy approach would have to help with guarantees, targeted incentives and regulatory interventions, for example, in order to noticeably redirect private investment.

Making climate-damaging investments unattractive

In addition to the targeted promotion of sustainable projects, it is also important to curb climate-damaging investments. It would be conceivable, for example, to exclude fossil fuel assets from the European Central Bank's collateral framework. This would significantly reduce their liquidity and thus their status as safe investments - with a direct impact on the willingness to invest.

In addition, regulation would also have to include so-called shadow banks, i.e. unregulated financial players that have so far largely operated outside the scope of political intervention and contribute to the financing of climate-damaging activities.

However, not all green investments can be financed via the market - such as infrastructure for cycling, renaturalisation or flood protection. In these cases, the research team believes that the state has a duty. New financing instruments such as an EU climate fund, a "green golden rule" to exclude green investments from the debt calculation or targeted taxation could mobilise urgently needed funds.

Financial policy alone is not enough

At the same time, the researchers emphasise that the role of fiscal policy should not be overestimated. Florian Kern from the IÖW comments: "Fiscal and monetary policy alone are of course not enough. They must be flanked by coherent innovation, industrial, fiscal and sectoral policies in order to advance the green transformation in a socially just and ecologically effective way. Fiscal policy must effectively complement other policies in the area of environmental and economic policy, such as measures for the energy transition, resource protection or the circular economy."

Research with an impact

For Silke Stremlau, Chairwoman of the Sustainable Finance Advisory Board of the last German government, the project provides valuable input for the political debate: "The team's researchers have succeeded in using their analytical lens to focus attention on the gaps in the current sustainable finance discourse. The question of whether the current measures are sufficient and what we can do if this is not the case is essential for the progress of the green transformation. With the policy recommendations, a consistent set of measures is now on the table."

The full findings and recommendations can be found in the policy brief "Financing the Green Transformation" published today.