Image Source: World Bank

A new World Bank report highlights critical issues facing banks in Emerging Market and Developing Economies (EMDEs) as they grapple with climate financing and financial stability. According to the report, a significant portion of these banks—almost 60%—direct less than 5% of their lending toward climate-related investments. In fact, more than a quarter of banks in these regions offer no climate financing at all.

This lack of investment is troubling given that banks in developing economies are the primary financial institutions, unlike in advanced economies where there is greater sector diversification. The absence of sufficient climate-related funding is particularly concerning as climate change is poised to affect economic development and opportunities in these regions significantly.

Axel van Trotsenburg, World Bank Senior Managing Director of Development Policy and Partnerships, emphasized the need for increased climate action. “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,” he said. He underscored the vital role that the banking sector could play in facilitating a green and sustainable development path.

Globally, banking authorities are exploring new strategies to boost climate financing while maintaining financial sector stability. One such strategy involves the adoption of green and sustainable taxonomies, which help classify and guide investments towards environmental goals. However, these taxonomies currently cover only 10% of EMDEs compared to 76% of advanced economies.

The report also highlights a critical shortfall in funding for climate adaptation, with only 16% of climate finance in EMDEs allocated for this purpose. Of this, 98% comes from public resources or official financing, indicating a significant reliance on non-private sources.

Additionally, the report, titled Finance and Prosperity 2024, outlines broader financial stability issues. It reveals that 30% of 50 analyzed countries face high financial sector risks within the next year. Many of these countries lack the necessary policy frameworks and institutional capacities to address these challenges effectively. A concerning trend is the growing exposure of banks to government debt, which has increased by over 35% from 2012 to 2023. This dependency could exacerbate financial instability, especially in economies with weak macroeconomic policies.

The World Bank report advocates for several measures to address these challenges, including strengthening bank buffers, improving financial safety nets, conducting stress tests, and establishing robust crisis-management systems. The introduction of disclosure requirements for banks’ government exposures is also recommended to promote prudent risk-taking and market discipline.

As emerging markets face these dual challenges of climate financing and financial stability, it is crucial for both governments and financial institutions to take coordinated action to support sustainable and resilient economic development.