EXECUTIVE SUMMARY

Inclusive Green Finance (IGF) is an emerging policy priority, championed by central banks and financial regulators in the AFI network to help mitigate, and build resilience to, the negative impacts of climate change and biodiversity loss. AFI member institutions agree that policies must address climate change without leading to financial exclusion, and that actively promoting financial inclusion as a tool for climate mitigation and adaptation, reduces environmental degradation, as established in the Sharm El Sheikh Accord (2017) and renewed at the Dead Sea (2022).

Based on research, international approaches and AFI members’ experiences, this roadmap to implement IGF policies (Roadmap to IGF) provides guidance on what central banks and financial regulators can do, on both a small and large scale, to further financial inclusion and enhance climate change resilience in AFI member countries. This special report, which identifies IGF as a subset of sustainable finance, shows that a successful IGF framework rests on six ‘Building Blocks,’ identifies policy tools to further advance the framework, summarizes the related challenges, and provides recommendations for IGF policy implementation. Each country has specific climate-related challenges and financial objectives; therefore, the preferable pathway depends on the country’s context, priorities, size of its banking sector, availability and readiness of credit financing schemes, significance of its capital markets, level of development of its digital retail payment system, and market size of its digital financial services (DFS).

IGF, which focuses on individuals and micro, small and medium enterprises (MSMEs), two groups to which financial inclusion provides the broadest societal benefits, describes a coherent ‘holistic’ policy supporting both financial inclusion (as a social goal) and adherence to environmental factors. However, IGF involves more than just access to financial services, regulators must focus on the valuable use of these services and how they benefit individuals and MSMEs.

THE SIX BUILDING BLOCKS OF A SUCCESSFUL IGF FRAMEWORK IDENTIFIED IN THIS REPORT ARE:

ADOPTION OF AN IGF STRATEGY

CLASSIFICATION OF IGF ESTABLISHING IGF AS A PRIORITY

DATA AND MODELS BUILDING THE IGF ECOSYSTEM

BUILDING A FINANCIAL INFRASTRUCTURE

REGULATORS MAY DEVELOP AND STRENGTHEN THE IGF FRAMEWORK WITH FIVE POLICY TOOLS:

ADVOCATING FOR IGF

CAPACITY BUILDING FINANCIAL INCENTIVES

VOLUNTARY STANDARDS AND RECOMMENDATIONS MANDATORY FINANCIAL REGULATIONS

An IGF policy is necessary for two reasons. First, markets are poor at assessing uncertain, long-term risks due to the lack of reliable data regarding the future trajectory of climate change. Second, the benefits of IGF are primarily societal and long-term, although the long-term consequences of failure will certainly be shown at the individual level as well. As such, both IGF objectives are ‘public goods’: individual counterparties do not directly reap the full benefits from investments in financial inclusion and environmental protection. In the absence of public policy action, private actors tend to under-invest in financial inclusion and environmental protection.

Much can be learned from the early approaches to sustainable finance regulation worldwide. The European Union is working on a fully-fledged revamp of financial regulation based on ‘double materiality’, an approach that factors in both sustainability risks and the impact of financial activities on sustainability factors. Yet it is too early to assess whether these ambitious reforms will lead to fundamental changes in economic activity. The EU’s approach has focused, to date, on large companies where cost concerns are less important. By contrast, costs in AFI countries deserve particular attention since most will end up as transaction costs typically paid by poorer members of society, with clear exclusionary risks.

Some AFI member institutions have pursued IGF by issuing Sustainable Banking Principles and ESG-related Sustainable Frameworks. These principles generally comprise risk management requirements, sustainability reporting, and governance requirements. While sustainability risks fall within the logic of traditional credit risk management, the same is not true for the impact of the lending activity of institutions on sustainability factors. Beyond reporting, regulators must actively ensure that these externalities are prioritized within the financial institution under supervision. This is particularly the case where an institution’s shortterm interest in profiting from unsustainable businesses collide with the public interest in protecting the environment long-term.

The international discussion is ongoing, specifically for individuals and MSMEs, as to the level of granularity that is feasible in data collection and risk management. The answer to this question will be country-specific and depend on the level of datafication of the public administration and MSME clients. Bulk and sectoral approaches, similar to international standards for capital requirements and new international sustainability standards, may well be in order. IGF frameworks require solid, long-term political support driven by a dynamic regulator with devoted expert resources and a strong role in shaping the regulatory framework.

Depending on the level of ambition relating to the Roadmap to IGF and the need to harmonize with other national and international frameworks, a Roadmap to IGF may consume an amount of regulatory capital that will need to be committed upfront.

Regulators will need more of their existing resources and entirely new types of resources in technology, hard science and data generation. Nevertheless, significant uncertainty remains on to reduce the negative impacts of business activity on the environment while ensuring financial inclusion. The three imperatives of IGF – financial inclusion, fostering resilience to and mitigation of climate disaster events, and supporting transformation to a sustainable economy – are at times in tension, especially for MSMEs and individuals, and these tensions may not be initially apparent. IGF frameworks will therefore, at times, require quick rebalancing and ad-hoc decision-making. Accordingly, dynamic governance systems with the readiness to constantly reassess policy approaches are also needed.

Each step will require refinement over time, in proportion to the capacity of regulators and regulated institutions. For instance, members can begin with Sustainable Banking Principles of a more general nature, which can be supplemented in due course with relevant and detailed guidelines or different tools like green lending procedures through the Environmental & Social Risk Management guidelines.

Both financial inclusion and climate change concerns differ from country to country, and while mutual learning from other countries is essential, the solutions must be country-specific and tailor-made to the necessities of each AFI member.