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A new report by the World Bank says, in almost 60% of banks in Emerging Market and Developing Economies (EMDEs), lending for climate-related investment accounts for less than 5% of their overall portfolios, and more than one-quarter offer no climate financing at all.

According to a statement by the Bank, this is significant because in developing economies, banks dominate the financial sector, unlike in advanced economies where the sector is more diversified. Climate change is expected to have a significant impact on economic opportunities and development outcomes in EMDEs, requiring far greater investment than they currently receive. Banks in EMDEs have the potential to play a larger role in closing the climate financing gap.  

“Emerging market and developing economies face substantial financing gaps in low-carbon, climate-resilient investments,” Axel van Trotsenburg, World Bank Senior Managing Director of Development Policy and Partnerships, said in a statement. “We need to step up climate action and crowd in private investment for countries most in need. This requires collective action, and the banking sector is indispensable in this transition process. It can play a pivotal role in financing a green, low-carbon, and sustainable development path.”  

Globally, banking authorities are testing new approaches to support climate financing, without compromising on the important goals of financial sector stability and inclusion for underserved people, according to the statement. For example, the adoption of green and sustainable taxonomies – a classification system that identifies activities and investments to move countries toward specific environmental and other targets – is essential to increasing climate-related lending. Today they cover only 10% of EMDEs compared with 76% of advanced economies.

“Adaptation is underfunded – only 16% of domestic and international climate finance in emerging market and developing economies is channelled for adaptation. Out of this small share, 98% is either public resources or official financing,” said Pablo Saavedra, World Bank Vice President for Prosperity. “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, Finance and Prosperity 2024, is the inaugural edition of an annual series that examines financial sector developments and vulnerabilities in low- and middle-income countries. It includes two special topics: Sovereign-Bank Nexus and Climate and the Banking Sector.

Based on new data, the report highlights a divergence in the resilience and stability of financial sectors. An analysis of 50 countries, which represent 93% of total bank assets in EMDEs, found that 30% of these countries face high financial-sector risks in the next 12 months. The majority do not have an adequate policy framework and the institutional capacity to deal with financial stability challenges.

The report also calls attention to the excessive holdings of government debt by domestic banks – an Achilles heel for some economies – particularly those with weaker macroeconomic policies, facing public debt sustainability challenges. Between 2012 and 2023, the exposure of banks to government debt surged by over 35%.

The report recommends countries to strengthen bank buffers well in advance, operationalise financial safety nets, conduct stress tests, and put in place a variety of essential tools. These include strong interagency crisis-management mechanisms, fully operational emergency liquidity assistance, robust bank resolution frameworks, and adequately funded deposit insurance systems to reduce the likelihood of financial stress and spillovers to the overall economy.

Additionally, the advises that developing economies should consider introducing disclosure requirements for banks’ exposures to the government to encourage more prudent risk-taking by banks and foster market discipline.