The urgent need to do something — anything — to halt climate change is the justification given for encouraging banks to fund green projects by offering them better capital treatment on these investments.
European Commission vice-president Valdis Dombrovskis said last week that the Commission is considering giving green assets capital relief, allowing banks to use less capital when financing, for example, energy-efficient homes. The idea has been floating around for some time, but Dombrovskis’s comments were the clearest indication yet that policy could be about to change.
Capital regulations were designed to make banks sturdier, so using them to incentivise green funding a bizarre proposition.
Capital requirements, calculated by measuring the amount of risk on a bank’s balance sheet, aim to make banks more likely to keep their metaphorical heads above the figurative water in the event of a crisis.
Green financing is there to ensure everyone else — not just the banks — is literally above the actual water, financial crisis or not.
Both are important, but mingling the two ideas risks undermining them both. This is why some politicians from green political parties are actually against the idea.
Advocates of green capital relief could point out that in other areas the link between capital requirements and credit risk has already been broken. EU banks are encouraged to lend to small and medium-sized enterprises through a “supporting factor”, and sovereign bonds have a risk weighting of 0%. But this does not in itself make another distortion right.
But even if banks are the means through which green finance should be promoted, market regulators can pull other, less hazardous levers to do so. The Climate Bonds Initiative, a group working to mobilise green capital markets, and which is in favour of the green capital relief idea, has set out other ways central banks could give preference to sustainable finance.
One way is to target quantitative easing (QE) at green debt. The European Central Bank and the Bank of England’s asset purchase programmes are currently skewed towards high carbon products, and instead central banks could rotate into green. This is no less intrusive than suggestions for 'helicopter' QE.
Another is to set up official guidelines and definitions for green investment products, something which Dombrovskis said was the Commission’s goal. This would add legitimacy to the industry and help to scrutinise the environmental benefits of such products, which will become more and more important as the market grows.
If authorities do decide using capital requirements is the only way to make the world greener, giving 'brown' environmentally unfriendly assets a higher risk weighting could be safer than lowering the weighting for green products, as it would discourage harmful investments without creating an extra loophole.
It is hard to oppose green capital relief too strongly when better strategies to tackle climate change are not being looked at. But the momentum behind it would be better placed elsewhere.