World Bank Warns of Growing Climate Financing Gap in Emerging Markets

WASHINGTON, August 29, 2024 — A new World Bank report has revealed that nearly 60% of banks in Emerging Market and Developing Economies (EMDEs) allocate less than 5% of their lending portfolios to climate-related investments, with over a quarter offering no climate financing at all. This concerning trend underlines the urgent need for action to address both the financing gaps for climate adaptation and the financial sector’s vulnerabilities in these regions.

The report, Finance and Prosperity 2024, highlights the significant role that banks in developing economies can play in bridging the climate financing gap. Unlike advanced economies, where the financial sector is more diverse, banks dominate the financial landscape in EMDEs. With climate change poised to impact economic opportunities and development in these regions, the report stresses the necessity for far greater investment than is currently available.

Axel van Trotsenburg, Senior Managing Director of Development Policy and Partnerships at the World Bank, emphasized the crucial role of the financial sector in facilitating this transition. “Emerging market and developing economies face substantial financing gaps in low-carbon, climate-resilient investments. We need to step up climate action and crowd in private investment for countries most in need,” said van Trotsenburg. He added, “This requires collective action, and the banking sector is indispensable in this transition process.”

The report also highlights the relatively low adoption of green and sustainable taxonomies in EMDEs, which are critical for increasing climate-related lending. These taxonomies, which classify activities and investments aligned with environmental and sustainability goals, are currently implemented in only 10% of EMDEs, compared to 76% of advanced economies. Expanding their use could catalyze more climate-focused financing, without compromising financial stability or inclusion, the report suggests.

Another key finding of the report is the chronic underfunding of climate adaptation in EMDEs. Only 16% of domestic and international climate finance is directed toward adaptation, and of that, 98% comes from public or official sources. Pablo Saavedra, World Bank Vice President for Prosperity, stressed the importance of addressing this funding shortfall: “In addition to increased climate-lending from banks, reducing this gap requires larger capital and insurance markets in developing economies to provide essential long-term funding for critical climate-resilient infrastructure. It’s also important to improve financial access for people, particularly those in vulnerable groups.”

The report’s analysis, covering 50 countries that account for 93% of total bank assets in EMDEs, reveals troubling financial sector risks. Around 30% of these countries are likely to face high financial-sector risks in the next 12 months, and most lack the policy frameworks or institutional capacity to manage these challenges effectively. The report points to excessive holdings of government debt by domestic banks as a significant vulnerability, particularly in economies with weaker macroeconomic policies and public debt sustainability issues. Between 2012 and 2023, the exposure of banks in these regions to government debt increased by over 35%.

To mitigate these risks, the World Bank report recommends that countries in EMDEs strengthen their banking sector buffers, operationalize financial safety nets, and conduct regular stress tests. It also calls for the implementation of crisis-management mechanisms, emergency liquidity assistance, robust bank resolution frameworks, and adequately funded deposit insurance systems. Additionally, the introduction of disclosure requirements for banks’ exposures to government debt could help foster more prudent risk-taking and enhance market discipline.

With global efforts to combat climate change intensifying, the World Bank report underscores the critical role of the banking sector in financing the transition to a low-carbon, sustainable future in emerging markets. Without significant reforms and investment, however, these economies risk being left behind. Read Full Report.