The Role of Green Financial Sector Initiatives in the Low-Carbon Transition: A Theory of Change

Green financial sector initiatives, including financial policies, regulations, and instruments, could play an important role in the low-carbon transition by supporting countries in the implementation of economic policies aimed to decarbonize their economy. Thus, it is fundamental to understand the conditions under which and the extent to which green financial sector initiatives could enable the scaling up of green investments and the achievement of national climate mitigation objectives, while, at the same time, avoiding unintended effects on macroeconomic and financial stability. However, this understanding is currently limited, in particular in the context of emerging markets and developing economies. This paper contributes to filling this knowledge gap by analyzing opportunities and challenges associated with the implementation of green financial sector initiatives. It also considers the specificities of green financial sector initiatives in emerging markets and developing economies, which are often characterized by budget constraints, debt sustainability concerns, and limited access to finance. The analysis focuses on green macroprudential policies, green monetary policies, and green public co-funding. For each green financial sector initiative, the paper qualitatively investigates the transmission channels through which it affects the availability and cost of capital for high- and low-carbon goods, but also investments, output, and greenhouse gas emissions, considering the design and implementation of the green financial sector initiative. For each green financial sector initiative, the paper further identifies its entry point in the economy and its direct and indirect impacts. Building on these insights, the paper develops a theory of change about the role of green financial sector initiatives in climate mitigation and in the low-carbon transition, identifying the criteria for applicability and conditions to maximize impact.