A scientific, sustainable way to finance climate goals of countries

Globally, the jury is still out on whether central banks should focus on the narrow mandate of price stability or broaden their role to tackle climate change as well. One view is that autonomy, a cornerstone of central banking, is best retained through a narrow mandate. Hence, they must desist from being climate policymakers.
 

Thomas Jordan, the president of the Swiss National Bank, said at Davos 2024 that central banks do not have efficient and effective instruments to tackle climate change. A similar sentiment was echoed earlier by US Federal Reserve Chairman Jerome Powell, who said that central banks must stick to their knitting and not use monetary policy or supervisory tools to achieve climate goals.
 

Others say that climate change demands action from central bankers because risks have spillover impact on price stability and inflation. Further, any supervisory function of financial institutions must entail oversight of climate-related financial risks.
 

Debate aside, for the financial sector to meaningfully address climate change it is imperative to have a green taxonomy. A green taxonomy is a scientific framework to define whether an economic activity is environmentally sustainable. It is usually determined by governments and lawmakers. To implement it, the challenge lies in tackling climate change without undermining economic growth.
 

India has made significant progress in certain climate-related policies, but its green taxonomy is work in progress. There are valuable takeaways from other jurisdictions though.
 

Several countries have taxonomies that define what green financing is and what does not qualify is bucketed as brown or non-sustainable financing. Singapore has a more nuanced approach. 
 

In December 2023, the country’s Monetary Authority along with an industry-led taskforce launched the Singapore-Asia Taxonomy for Sustainable Finance. It is the world’s first multi-sector transition taxonomy and defines not just green but also transition activities in key sectors such as energy, transportation, agriculture and construction.
 

The approach is pragmatic as a large part of economic activity falls in between green and brown categories. The critical missing middle is addressed in the Singapore-Asia Taxonomy through a “traffic light” classification system. Green entails activities that are aligned with the 1.5 degrees Celsius pathways. Amber denotes activities that are transitioning or moving to green pathways over pre-defined timelines. For Singapore, the sunset date for an amber classification is 2030 or 2035 for certain harder-to abate sectors. Ineligible assets are classified red.
 

A fossil fuel power plant is typically an ineligible asset. With the transition taxonomy, if the plant is retrofitted with equipment to facilitate cleaner generation or if it is adopting decarbonisation technologies, the loan or investment qualifies as amber. 
 

A green taxonomy acts as a bridge between climate science and a usable guidance for the financial sector. India’s financial sector regulators such as the Reserve Bank of India, Securities and Exchange Board of India, and International Financial Services Centres Authority, have issued various green financing frameworks. A green taxonomy will bring in the much-needed harmonisation. More importantly, a standardised green taxonomy will protect the Indian financial system from unintentionally faltering on information asymmetry and avoid inconsistencies in classifying green assets.
 

A green taxonomy is the foundation upon which a financial system aligns with a country’s climate goals. It is not the intention to preclude financial institutions from lending to any hard-to-abate sectors. A green taxonomy will help channel capital flows for decarbonisation initiatives. Given that banks will play a pivotal role as providers of transition finance, a green taxonomy for India should be a priority. Time is of the essence and India should not fall behind.

The writer is head-ESG, HDFC Bank. The views expressed are personal